Waiting for the Turn
Sitting on the fence, waiting for the turn in macro economic indicators will disappoint and leave opportunity on the table. Rising correlations show investors are ignoring relative values among industries and assets, rather reacting to day-to-day signals on the economy. It is more likely that deflation and low growth will be the environment into the second half of the year, underscoring the need to diversify assets from a traditional long equity and bond portfolio.
Opportunities exist in right sized industries and companies and across asset classes. For companies that downsized, the benefits of incremental sales falling to the bottom line EPS have been borne out in Q2:10 earnings results. Indeed, the S&P 500 has rebounded 7.8% since July 2 despite weak economic data as corporate earnings have been stronger than analysts estimated on marginally higher revenues. With 53.4% of the S&P 500 reported, operating margins are 9.7% and could set a record.The record margin was 9.6% set in Q3,’06.
With over two thirds of companies reported Q2, EPS beat forecast by 10.2% while sales grew only 1.4% over estimates. While bears will point to no growth, 73.4% of companies have nonetheless beaten their sales estimate. In analyzing the data, non-Financials increased sales 5.2% over Q1,’10 (looking for momentum in the recovery). The Technology sector lead by companies like Intel and Apple standout as leading in positive revenue and EPS upside. Only companies in Health Care, Consumer Discretionary, and Financials have lowered forecasts. Financials revenues were down 7.3% from Q1,’10 estimates.
The result for rationalized companies can be positive longer-term, as they achieve greater efficiencies and production capacities fall better in line with actual demand. Thus we continue to see resiliency for the right sized companies.
With S&P 500 companies at record cash rich levels with close to $1 trillion, equity selection will be key for quality companies that will grow dividends and repurchase stock. The 5-year T-bill yields 1.75% versus average yield on the S&P 500 of 2.14% is favorable with a call option on growth as witnessed in Q2. Dividend payers have outperformed YTD and expect the hunt for yield to drive further performance in H2:10.
|Dividend Performance:||S&P 500 Payers||S&P 500 Non-payers|
|June – average change||-5.91%||-7.30%|
Aside from equities, investment opportunities also lie in credits where the companies have already gone through a restructuring/business rationalization process and therefore seem better prepared for the growth, albeit slow, prospects which lie ahead.
Both investment grade and High Yield corporate debt seem particularly attractive given the wide spreads to T-Bills, the fact that credit markets are opening for new issuance and default rates are predicted to decline to 2% to 4% in 2010/2011.
While we cannot predict economic or market moves month-to-month or even year-to-year, we do seek to identify the key long-term forces that will be driving economies and markets worldwide. We expect that volatility will remain high with growth, inflation remaining low and the FED on hold for sometime.
As a result, equity valuations may not move back to pre-crisis levels and may stay below historic norms. Thus our investors must seek a diversity of investments – our 8-Cylinder Portfolios – that assures to the greatest extent possible exposure to whatever areas of the market “are working” at any time, and handle the volatility via both long and short exposures and are not dependent on market gains for gains in their portfolios.
Looking ahead, we believe that uncertainty may be appropriate, but the fear trade to be overdone. The outlook is rarely clear, exacerbated by governmental programs and redefinition of the economic landscape. But, we remain confident in the CoreStates 8-Cylinder approach to navigate that volatility with opportunities that will meet the long-term financial goals of our clients.