posted 01/25/11 | Wealth Management
by D. Patrick Schumann, CFA
Director of Investments
Enterprise Trust Company
All things considered, it’s been a pretty good run. Since bottoming out on March 9, 2009, the S&P 500 is up 91.2% through the close on January 14, 2011.
Where do we go from here? The good news is that equities are still reasonably priced, in our view. Even with the rebound over the past 20 months or so, equities (as measured by the broader S&P 500) have just now recovered to the levels of August 2008, just before the peak of the financial crisis (several financial firms folded in September 2008, including Lehman Brothers). The S&P 500 would have to climb another 21.0% from today’s level just to match its all-time high of 1565.15 in October 2007. Currently, the S&P 500 is trading at 13.6 times the consensus forecast for 2011 earnings per share ($94.96). That is below the historical average closer to 15.
While there are challenges (housing, unemployment, Europe, credit disruptions), we believe there are numerous positives (improving global economy, steady U.S. growth, rebounding consumer spending, strong corporate earnings, low inflation and interest rates) that will help offset the challenges. Meanwhile, until recently, massive amounts of funds had been flowing into bond funds, due to higher levels of risk aversion, while equity funds had seen large withdrawals. Investors are sitting on a substantial pile of cash. There should be plenty of demand for equities, but investors have to get a comfort level with the ability of the U.S. economy to eventually overcome the challenges.
Much has been said about the “lost decade” for stocks, where the return on the S&P 500 Index averaged roughly -0.5% from the end of 2000 through the end of 2010. No doubt, for any investor heavily weighted to large-cap stocks during that timeframe, that is a performance many would like to forget. While we cannot change the past, we can point to history as a guide during other similar performances. Prior to this latest decade, there have been nine other rolling 10-year periods where the S&P 500 Index averaged a return of less than 5%, including two (1929-1938 and 1930-1939) that also had negative returns. In each case, the following period was much more palatable, as equity prices made up much of the lost ground. The average annual return for the next 10 years, after each of these nine periods, was 13.2%. The 20-year average return was 14.7%.
Of course, there is no guarantee we will repeat this history. In fact, given the maturity of the U.S. economy and the magnitude of current challenges, we do not expect to mirror those subsequent returns. However, we do believe equities are positioned to recover, just like in prior challenging periods, but just at a lower magnitude. Case in point, the S&P 500 was up over 6% in December and finished 2010 with a gain of almost 13%.
As always, we believe the U.S. presents a solid base of investing, and adding international equity exposure can give a portfolio additional growth (with additional risk, of course). Emerging markets, a subset of international) offers even higher growth, particularly in countries such as Brazil, China, India and Russia. As an example, China’s economy is still growing at close to 10%, even though its government has moved several times this year to slow its growth.
In summary, we believe equities are positioned for moderately positive gains over the next few years. For our investors, having proper exposure to equities within portfolios will be important to achieving investment goals