I once asked a shark attack victim if he still surfed. “Of course” he said, smiling. “What are the odds that another one gets me?”
Like surfers in search of the biggest wave, investors are heading back into the stock market waters thinking the odds of a 2008-style shark attack are small and that the market holds only the best stock picks. And they are probably right, at least for the moment. The economic numbers are improving notably, which suggests that stocks have further to go.
In the United States, jobless claims fell below 400,000 this past week for the first time since July 2008. Profits are beating expectations and consumers will likely spend more with slowly improving job numbers. As long as the profit picture and economic numbers continue improving, the S&P 500 will keep rallying.
What should investors do in such an environment?
Well, if the market is going up, investors should buy stocks that go up more. The U.S. stock market will always offer numerous opportunities for stock pickers from a bottom-up perspective. Those that have stuck with Amazon.com (NASDAQ: AMZN), Apple (NASDAQ: AAPL), Netflix (NASDAQ: NFLX) and other such innovators have reaped tremendous profits. Those stocks have gone up a lot since I mentioned them several times last summer and have massively outperformed the S&P 500.
Still, from a top-down perspective — the way I like to invest — you have to look harder at economies driven by sustainable savings-and-investment growth cycles, which are very different from ever-rising levels of borrowing happening in the developed world. I have long-term concerns about most developed markets — save for Germany — because I believe that balance sheets are more important than income statements. However, no one is looking at the U.S. macro balance sheet at present.
Debt-driven growth cycles tend to “hit an economic wall” as ever-rising amounts of debt produce very little in the way of incremental GDP growth. Still, it appears that the Federal Reserve and the administration will grab one final rabbit out of the debt bag. The macro imbalances are unlikely to be the story of 2011, which I expect to be an up year for stocks.
Over the long term, savings-and-investment growth cycles produce higher returns for equity investors as demonstrated by my favorite comparison of the 10-year trailing annualized returns of the largest S&P 500 index fund — the Vanguard 500 Index Investor (VFINX) — and a conservative Asian mutual fund like Matthews Asian Growth & Income Investor (MACSX). The Vanguard 500 Index delivered just 1.3% per year, versus an annual 15.3% for Matthews Asian Growth & Income over the past decade.
I am highly confident that this Asian (and broader emerging markets) outperformance will continue in 2011.
U.S. mutual fund investors have finally figured it out. Money flow data provided by the Investment Company Institute (ICI) suggests that since 2007 net inflows have consistently been going to foreign funds, while domestic funds have seen generally weak or negative net inflows.
Anyone involved in asset management is duly advised to spend some serious time increasing their offerings in emerging market and natural resource investment vehicles, because that is where the money is going.
I fully expect that this trend will accelerate in the next decade as the fundamentals — lower debt levels, higher savings rates and better demographics — suggest that economic growth will be faster and more sustainable in the emerging world. Invest accordingly.
