Newsletters 2010 Newsletters Outlook for 2011
Tuesday, 14 December 2010 08:30
The stock market caught its breath in November, with the S&P 500 Composite, Dow Jones Industrial Average and NASDAQ Composite declining 0.23%, 1.01% and 0.37% respectively. These important market barometers are now up 5.87%, 5.54% and 10.10% year-to-date through November. Despite a negative surprise from core holding Cisco Systems that weighed on our November results, the composite of all Osher Van de Voorde equities under management remains ahead of its key benchmark, the S&P 500 Composite, and is up 6.44% year-to-date.
In establishing our preliminary outlook for 2011, we dusted off last December’s “Outlook for 2010” to evaluate our prognostications for the current calendar year. One year ago, we established a price target range between 1200 on the low end and 1280 on the high end for the S&P 500. As we approach year-end, the S&P 500 sits at 1240, comfortably in the middle of this predicted range. Not only did we get the overall direction and range right, we accurately identified what proved to be the market’s greatest obstacle in 2010 – the “over-arching concern that the weight of growing deficits, higher taxes, a falling dollar and a weakened U.S. consumer leave the U.S. economy unable to reach escape velocity”. Indeed, 2010 witnessed a nasty 15% correction and several other minor dips accompanied by investor’s preoccupation with the possibility for a “double-dip” recession.
The markets have continued to successfully climb the “wall of worry” and, one by one, the market’s greatest obstacles are being removed.
Consider the following:
U.S. Economy
Fears for a double-dip seem to have been finally laid to rest. Despite the European debt crisis and the sluggish recovery in the U.S. housing market, the super tanker U.S. economy, buoyed by a surprisingly resilient consumer, has remained steady and has even shown recent signs of accelerating.
Third quarter GDP has been upwardly revised from 2.0% to 2.5%, with estimates for real final sales (which exclude inventory changes) revised up twice as high to 1.2% growth from 0.6%. Personal consumption for the third quarter was also revised higher from 2.5% to 2.8%. And productivity continues to surprise to the upside with third quarter productivity revised higher from 1.9% to 2.3%.
Economic data for the current quarter continues to provide evidence that the recovery remains on track. The ISM Service Index increased from 54.3 in October to 55.0 in November, while the ISM Manufacturing Index declined only slightly from 56.9 in October to 56.6 in November. The Conference Board’s Consumer Confidence Survey rose from 49.9 in October to a five-month high in November to 54.1, and the just-released University of Michigan Consumer Sentiment Index jumped to 74.2 In December from November’s 71.6, its highest level since June.
Meanwhile, retail sales for the important holiday shopping season have come in better than expected and auto sales rose 17% in November on a year over year basis. This recent economic strength prompted analysts at Goldman Sachs, among Wall Street’s most pessimistic prognosticators for 2011, to increase their 2011 GDP forecast to 2.7% from 2.0%, citing prospects for U.S. growth that had “brightened significantly in recent weeks”.
Global Economy
With U.S. economic growth steady but still below-trend, we have witnessed significant skepticism as to the ability for emerging and other developed economies alike to propel the global economy. Fears of an economic hard landing and real estate bubble in China are on the back burner for now and European austerity measures have not derailed the global recovery. The International Monetary Fund estimates that 2010 global GDP growth will register at 4.8% and now forecasts 2011 GDP growth at 4.2%.
And, similar to the data points here in the U.S., the evidence suggests that global growth may be strengthening. The Purchasing Managers Index in China rose from 54.7 in October to 55.2 in November, and the HSBC Purchasing Managers Index in South Korea rebounded sharply to 50.23 In November from October’s 20-month low of 46.75. Meanwhile, economic recoveries in Brazil and India remain well-entrenched with third quarter GDP growth at 6.7% in Brazil and 8.9% in India.
The biggest surprise may be found in Europe where the U.K.’s Purchasing Manager Index rose from 55.4 in October to 58 in November – this is the highest level of growth for U.K. manufacturing since 1994. German manufacturing is at its highest level since reunification and manufacturing in France recently hit a 10-year high. Strength in Germany and France are offsetting weakness elsewhere in the Euro-Zone and the Euro-zone Purchasing Managers Index rose from 54.6 In October to a four-month high of 55.3 in November. As the European economy rides the coattails of Britain, Germany and France, the ECB seems poised to introduce an even greater backstop (bailout) for structurally weak countries such as Greece and Ireland, beyond the existing $985 billion authority, to save the euro.
Politics
Our number one concern for the stock market as we entered 2010 was for the Obama Administration’s “fixation on policies that will grow the role of government and increase our already massive deficits to dangerously unacceptable levels”. While ObamaCare did muster enough support to become law, it did so without the more onerous “public option”, even though Democrats controlled both the House and Senate. The recent wave election that saw Republicans win control of the House, narrow the Democrat majority in the Senate and dramatically alter the legislative landscape at the state level introduces a new layer of gridlock that will prevent other anti-business platforms such as “cap and trade” and “card check”. In our January “What Could Go Right” newsletter article, we opined that the number one “rose colored” possibility for 2010 would be “the fiscally conservative, centrist-minded ‘tea party’ movement becomes a revolution and leads to the single-largest party turnover in the history of Congress, signaling the death of liberalism and the end of big government”. More checks and balances have been restored and a significant obstacle for the stock market has been removed.
Taxes
With the election in the rear view mirror and the policies of big government seemingly repudiated, we were very impressed with President Obama’s recent willingness to compromise with Republicans and agree to a two-year extension of the Bush tax structure for all Americans and for all taxes, including the advantaged rates on long-term capital gains and dividends. Further, the President agreed to establish an estate tax exemption at $5MM with a 35% tax rate on estates over $5MM. Assuming that the President’s proposed compromise finally passes through Congress, we believe that this just may be the greatest obstacle of all to be removed and will allow small businesses to implement more precise intermediate terms and create new jobs. Most economists predict that the extension of the Bush tax structure will add between 0.5% to 1.5% to GDP growth in 2011.
While the above obstacles have been eliminated, other obstacles always exist. Among the most significant obstacles we presently see for the stock market in 2011 include the threat of rising interest rates in the U.S., the potential unwillingness to tackle the structural deficits in the U.S., the continued U.S. housing market malaise, European debt contagion, inflation throughout emerging markets and geopolitical turmoil in hot spots such as Iran, Korea and Pakistan.
Despite these “new” obstacles, 2011 annual earnings for the S&P 500 Composite are presently expected to come in at $94.52. At its current level of 1240, the S&P 500 trades at 13 times next year’s expected earnings and at just under 15 times 2010’s $83.59 full-year estimate. With interest rates at such historically low levels, corporate balance sheets in such wonderful shape and with the economy sustaining itself at “Goldilocks” levels, a PE of 15 seems easily justified and a premium PE might even be warranted. Applying no premium to account for our new obstacles, the S&P 500 should be able to maintain an approximate 15 PE and so trade up to 1418, an approximate 15% increase from current levels. Our initial 2011 target range for the S&P 500 is between 1400 and 1425, an expected gain of 13% to 15%.
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