Robert Arnott was just on CNBC calling for 2-3% earnings growth per year for the next five to ten years, below, he says, the rate of inflation. This will result in a bear market but he did not quantify the magnitude of this bear he sees which I attribute more to the questions asked than anything else.
I see no reason to try to counterpoint his idea, it will be right or wrong. I think there is more utility for do-it-yourselfers to instead think about what they would do if it ever starts to look like he will be right. He likes TIPs and Local Market (foreign bonds) bonds.
I would also think that, relative to equities, the myriad of dividend ETFs might make sense. I also think the Currency shares, especially higher yielding products also might do well (the idea is a bear market combined with the Fed lowering rates would cause a decline in the dollar). Foreign stocks from countries that don't export consumer goods heavily to the US, here Sweden, Chile, Australia come to mind first, might work. I think staples would stand up too. One last one I would mention is certain emerging markets that are in their own world in terms of their growth stories. Here I think of places like Hungary, Poland, Iceland and Vietnam. To be clear these countries have their problems but they are not too dependent on the fate of the US.
This is just meant to be something to put on the back burner. Arnott's scenario is not unfolding now. But it is kind of a dour outlook from a smart guy. There is nothing wrong with thinking about what you would do now while there are no emotions clouding your logic.
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17 comments:
Roger – appreciate the blog. Insightful posts, you’re on my daily hit list.
These comments by Arnott are interesting. I’ve seen him speak a couple times and read his articles when he provides something for the Financial Analysts Journal. I respect his opinion and in this case tend to agree with him.
Corporate earnings have grown at breakneck rates and way above historical norms. My data off of First Call is showing S&P earnings growing 11% this year and 7% next year.
A mean reverting, earnings slowdown is inevitable and already beginning. Here’s what worries me – often, when we see mean reversions the numbers typically do not stop at the historical mean and then stop. They blow through them (in this case to the downside) and then trend higher and stabilize along that mean level.
Let’s say 2007 earnings growth does revert back to the mean levels (6%). That puts S&P earnings at about $90/sh in 2007. What kind of multiple should US investors pay on average growth. How about an average multiple? John Hussman states that the average price to peak earnings multiple on the S&P is about 14x (http://www.hussmanfunds.com/wmc/wmc041227.htm). At a 14x multiple and 6% growth, the S&P would be 1250 at the end of next year (-10% from today’s levels).
What kind of multiple should be applied to the S&P if growth is below 6% as Arnott expects. Who knows? What I do know is that new, long standing bull markets do not begin when the trailing earnings multiple on the S&P is 17x, the Dow is 25x and the R2000 is at 35x. Historically bull market begin when earnings multiples are in the high single digits (1942, 1982). If we happen to get EPS growth of 6% in 2007, 3% in 2008 and further multiple compression, I could envision see a scenario where the market sees two years in a row of negative returns in the 10% - 15% range.
I’m only 31, so in the end I know I’ll survive any major market calamities with the opportunity to invest at much more attractive multiples. Despite my gloomy outlook for the US market I’m still long with 85% of my portfolio (60% of that international) knowing that if I’m wrong it won’t really hurt much. But, I have begun taking put positions on the US markets using LEAPs to cushion some of the fall should it occur.
Keep up the good work.
Can't see the forest because of the trees. Without a national will on our part to defend and promote democracy and the wonderful benefits of capitalism, does one think for a minute that our strategic enemies will permit the markets to behave rationally, if at all?
Don't look up---the sky is indeed falling. For Arnott to be right, we would have to ASSUME:
1) Rates will have to collapse.
2) The smart money that is now buying the market, is dumb.
3) The dollar will collapse.
4) Calamity in the streets.
Doom
Gloom
Suffering
Pain
Some people see the glass as half empty.....
g
Wondeful thing about Google is that you can go back and see what Arnott is saying since 2003.
It has remained same, while the market has gone up significatly. Trading based on such macro themes is extremely difficult and many of these themes never materialise.
thanks for the comments.
Pix is right to point out the extremes that exist today with some of the valuations. It does seem like at any point in time we can find something that makes stocks look very overvalued. I view PEs as a part of the puzzle to be sure but there are, for me, other parts too.
Pradeep, nice detective work I did not know that about Arnott.
I still think it is worthwhile to devote a little time to thinking about how various scenarios could play out.
I would also say it's worth looking at the track records of the two asset-allocation funds he runs for PIMCO (they're both All Asset funds). Not very impressive, but then this market seems to have a lot of the smart money stumped.
Well it's important to diversify so I think I would take some Chinese bank stocks (known for their superior loan quality), some Florida Condos, and some of those rare Pokémon cards from a few years ago. We could make an ETF out of it and call it the diversified Ponzi fund. The first 100 investors make vast multiples of money - I'm already in.
don't get caught the wrong way on the Pokemon cards. Fool me once...
Great post pix and good blog rog.
m
Disagree with "anon", the smart money is NOT fooled. It has been buying. The smart money is the BIG money. The big money is smart because it had to be smart to get big. Get it? Anyway, the smart money is buying..otherwise...the market would Not be going up. Because there is not enough dumb money to make the market move.
There are, of course, some charts of this that I can not share because of copyright laws.
g
I wouldn't be surprised if Arnott turns out to be right. Although we've enjoyed a great cyclical bull market since late 2002, I believe we're just six and a half years into a secular bear market. Depending on exactly where you think past secular cycles began and ended, the average length of a secular bear is somewhere in the neighborhood of 14 to 18 years. That means many investors might do no better than tread water for the next decade.
Here's an interesting article that touches on some strategies that might better weather a secular bear.
http://www.fpanet.org/journal/articles/2006_Issues/jfp0306-art7.cfm
I believe that with the proliferation of all of these hedge funds, that the smart money is not much smarter than the rest of us. We're just lucky to get in behind it or out ahead of it. With respect to prognostications of any sort...smart folks on polarized ends that are emphatic that their view is the right one. Hard for us mere mortals to know the skinny. My Armenian grandmother would say each year the world was going to end. I suppose if you predict catastrophic events (something more probable than the world ending, such as war, recession, etc) then one day you will be right though for many days you have been wrong.
Re the Australia ETF, similar to Canada's, Roger, aren't they tied to commodities? I surmise, then, thatif we are recessionary and commodity prices are coming down, both of those funds would be tied closely to that event.
Leisa,
australia is like canada-commodity based. The idea behind my comment was that they don't export a lot of ocmmodities to the US but do export a lot to China. The China story could be a in its own world type story in terms of demand for resources as it modernizes. I don't think China would get killed by a normal recession here. If it the US had a severe recession it may be different.
TomK a treading of water would not be the worst thing in the world even if it was not good.
BTW TomK's link was truncated but you can click here to read it which is probably worthwhile.
Re: comments about Bob Arnott and two PIMCO's all asset funds.
I beleive these funds are combination of bond/cash and stock futures. Actually they are mostly bonds. Do they reflect Bob' ability in predicting long term market trend? Of course not. Whoever try to compare short term performance to long term prediction will be dealing with noises.
BTW, I look at many so-called experts' portfolios(such as by MSN Money), most of their YTD results lag S$P 500.
I just love comments like "cyclical bear/bull market".
Which market are you talking about?
S&P500
Midcaps ( Growth or Value)
Smallcaps ( "")
International???
Emerging Markets?
Bonds? ( Which kinds--muni--high yield-govies-foreign-agencies????)
Money market ( I'd say we are in a bull market in money markets yielding almost 5% )
WHICH MAARKET?
During the last BIG BEAR that everyone identifies with ( 1968-1982 ) IF you were in small-midcap stocks or some international---you never saw a "Bear Market"
Wake up people! This is what Roger is trying to tell you: if you are in various areas of these marketS--you'll do fine. And, no...the sky will not fall on your head.
g
You mention locales out of the usual trading opportunities -- e.g., Iceland, Hungary and Poland. What type of equity investments are readily available for these economies for an ordinary investor?
readily available? depends on your idea of readily.
Iceland is tough. I have an account at a bank in Iceland that took several months to open and fund. Kaupthing Bank has a listing in Stockholm (KAUP.ST) that I was able to trade at Schwab-I don't own it anymore. Decode Genetics (which I know zero about) has a Nasdaq listing and is somehow tied in to Iceland.
There is one NYSE listed Hungarian ADRE Magyar Telecom (MTA). There are other stocks that trade here on the Pink Sheets that can be traded through Schwab, ditto Poland.
There are 3 cefs that I know of for central or easter europe that may have these two countries, you can check for yourself. The three are CEE, TRF and RNE.
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