On January 6, 1999, the Standard & Poor’s 500 Index, a commonly used benchmark for the US stock market, reached 1,257.60 for the first time. On December 31, 2011, 12 years later, the index closed at exactly the same level.
Since the global financial crisis in 2008, American investor sentiment overall has declined. Americans have pulled out hundreds of billions of dollars from equity mutual funds in what seems to be a loss of faith in the stock market.
And then there was 2011, a year of economic shocks: the earthquake in Japan, the US debt ceiling impasse, the euro crisis, and the US government’s loss of its prized AAA long-term credit rating. Despite that backdrop, which is one of extreme worry and risk aversion, there is a case to be optimistic on the performance of the US equity market in 2012.
The US market didn’t do that badly in 2011. While the S&P was flat, the Dow Jones Industrial Average was up 5.5 per cent – the third straight year of gains. The DJIA was up 11 per cent in 2010 and 18.8 per cent in 2009, following the 33.8 per cent fall in 2008. The 2011 DJIA performance was the best of all developed markets as evidenced on the attached chart.
The general view of the US in 2012 is that it is the best house in a bad neighborhood.
In the heat of the 2011 summer, concerns about a double-dip recession in the US intensified, leading to severe drops in the market and stomach-wrenching volatility. Gross domestic product is expected to be 2 per cent for 2011, accelerating throughout the year with the fourth quarter expected to exceed 3 per cent.
In September, the IMF downgraded the US 2012 GDP forecast to 1.8 per cent. However, the general consensus is that the US will bump along at 2 per cent, despite GDP deceleration in Europe and slower growth in Asia.
There are plenty of bright spots in the US economy. US manufacturing expanded for its 28th consecutive month in November, with steady gains in demand and production boosting conditions to their highest levels in five months.
Unemployment fell to 8.5 per cent in December, the lowest level since February 2009, and well off the 9.9 per cent rate in May 2010. This trend is expected to continue as corporate profits reach an all-time high, and job growth is always a lagging indicator.
US company balance sheets are flush with a record US$2 trillion in cash and cautiously low inventories in a situation of increasing demand, thus creating the potential for significant capital investment and further employment gains.
Perhaps the strongest argument is the incredible growth in US corporate earnings and the fact that profit margins are at one of their highest points in history. The S&P 500 companies are expected to earn $1.04 trillion in 2012, compared to $543.2 billion in 2009.
With earnings per share of $96 expected in 2011, the S&P is trading close to 14 times earnings, with an earnings yield of 7 per cent versus 2 per cent for the 10-year Treasury.
The earnings yield shows the percentage of each dollar invested in the stock that was earned by the company, and money managers consider a yield that is higher than prevailing interest rates to be a sign that stocks are undervalued relative to bonds.
Meanwhile, the mean EPS forecast for the S&P is $102.40, or a price-to-earnings ratio of about 12 versus the historical median of 15.7, further showing that stocks may be undervalued.
This year is an election year in the US, and the S&P has historically posted 7.8 per cent gains in election years. Potential further catalysts are a bottoming housing market and recovery, and a third round of quantitative easing from the Federal Reserve.
Sure, there is a lot that can go wrong, but it may be time to look at the glass as half-full for the US market.
Anthony Galliano is chief executive of Cambodian Investment Management. [email protected]