Sunday 26 December 2010

Taking stock of global opportunities in 2011

By Andrew Tanzer
Saturday, December 25, 2010; 11:32 PM

To understand the investing outlook for 2011, let's look back. Despite emerging from a long and brutal recession, the economy mustered only an anemic expansion in 2010. The most notable manifestation of the tepid recovery was a high jobless rate that scarcely budged all year. And yet, over the past year (through Nov. 5), the U.S. stock market managed to post an impressive 17.3 percent return.

The same pattern - a stagnant economy but a decent stock performance - may repeat in 2011. The economy should grow by little more than 2.5 percent, and the jobless rate could even tick up to 10 percent. But stocks could still return 7 to 10 percent over the next year, in line with corporate earnings growth and the market's current dividend yield of 1.9 percent. The Dow Jones industrial average should finish 2011 above 12,000.

How to explain the apparent disconnect between the muddle-through economy and the perky stock market? A number of factors contributed. Interest rates are already at rock-bottom levels, and the Federal Reserve Board says it plans to buy $600 billion in Treasuries by the middle of 2011 to keep rates low. The balance sheets of U.S. companies, unlike those of our government and households, are in excellent shape. Profits should continue to rise moderately in 2011 and match or exceed the record level, set in 2006. With Standard & Poor's 500-stock index selling at 13 times projected 2011 earnings, stocks do not appear to be excessively valued, especially relative to bonds and cash.

Don't forget that the S&P 500 companies earn 40 percent of profits abroad, where growth is higher than at home. David Bianco, chief stock strategist of Bank of America Merrill Lynch, calculates that profit margins of U.S. companies are far higher overseas. Bianco says four sectors in the S&P index - technology, energy, materials and industrials - are generating more than half their profits abroad.

Profit increases in 2010 at global companies such as Boeing, Caterpillar and Coca-Cola were powered by buoyant growth in developing countries - economies that Merrill Lynch projects will generate no less than 75 percent of the world's economic growth in 2011.

Risks to watch

Also in 2011, the shift in control of Congress, which will be split between a Republican House and a Democratic Senate, will likely produce political gridlock. Some observers think that could be good for stocks because Congress won't be able to enact laws that could harm business. It could be a negative if lawmakers are unable to address a financial emergency.

We'd be remiss if we didn't outline some of the risks and lingering structural weaknesses in the economy. Recognizing risks as they come to the fore may help you make midcourse corrections in 2011 and beyond.

Volatility should remain high in 2011 because of contradictory signals from an economy that is expanding in fits and starts. Even Federal Reserve Chairman Ben Bernanke frets about an "unusually uncertain" environment. He and most Fed governors think inflation is too low and clearly seek to engineer higher price increases through ultra-loose monetary policy. Because the Fed's gambit is untested, there is a risk that the inflation genie will escape the bottle.

Government monetary and budget policies are helping to drive the dollar lower, which aids U.S. corporate profits. The trouble is that many other governments are also cheapening their currencies to juice exports and job growth. There is a chance this race to the currency bottom, which is a form of protectionism, could degenerate into a trade war.

Bond outlook

After years of delivering stunning gains, bonds may be a less-comfortable resting place for your money in 2011. During 2009 and 2010, individual investors poured more than $600 billion into bond funds. But a rise in long-term interest rates - a distinct possibility in 2011 - could result in losses for many bondholders.

Surveying the risks stemming from currency wars, and from rising inflation, interest rates and the sluggish domestic economy, one analyst concludes that investors would be wise to embrace global investing.

"A lot of U.S. investors need to make a paradigm shift in 2011," says Dean Junkans, chief investment officer for Wells Fargo Private Bank. "Think of yourself as a global investor living in the U.S. rather than as a U.S. investor with some global exposure."

In his portfolios, Junkans says, he's increased foreign exposure "permanently" by 50 percent over the past four years.

Any pessimism about prospects for the economy stems largely from that familiar trinity of linked problems - housing, banking and busted household balance sheets - which will dog us for a few more years.

Gauging opportunity

So where do you invest if growth remains sluggish in 2011? One idea is to look for companies that can expand revenues much faster than the overall rate of economic growth, such as Apple and Marvell Technology, a maker of microprocessors and storage devices. Or look for multinational corporations that can tap into much stronger growth abroad, especially in vibrant developing nations.

What makes blue-chip companies especially intriguing is that they appear to be attractively priced relative to the market and to their own past levels of value. Moreover, many of these companies come with sturdy balance sheets - which provide a measure of safety in an uncertain economic environment - and proven, consistent business models.

One sweet spot in the market is blue chips with direct or indirect exposure to emerging markets. For instance, says Channing Smith, co-manager of Capital Advisors Growth Fund, companies such as Procter & Gamble, Pepsi, IBM and ExxonMobil.

Michael Keller, co-manager of BBH Core Select Fund, likes multinationals that sell products that consumers in emerging markets buy on a regular basis, such as Nestle, the Swiss food giant, with its powerful global brands and distribution capabilities, and Baxter, which he thinks will benefit from a sharper focus on health care and hygiene in developing nations.

Sometimes you can find companies that can grow faster than the economy at home and ride brisker economic growth abroad. Jim Tierney, chief investment officer of money manager W.P. Stewart, sees such possibility in Polo Ralph Lauren and MasterCard. Ralph Lauren is expanding globally - with new stores in Chile, Korea and Malaysia - and extending its product line into watches, jewelry and sunglasses. MasterCard benefits from the growing use of credit cards all over the world.

U.S. companies gain when they produce abroad or export goods and services to foreign consumers, factories or infrastructure projects. But companies can indirectly benefit from rising emerging-market economies. For example, Ed Maran, co-manager of Thornburg Value Fund, is high on U.S. Steel, a domestic producer, because the strength of developing nations boosts steel prices - and profits.

Urbanization, industrialization and rising living standards in the developing world will drive up commodity prices, says Evan Smith, co-manager of U.S. Global Investors Resources Fund.

Jordan Opportunity Fund's Jerry Jordan is bullish on agribusiness. As rural migrants flock to cities, and as incomes rise in countries such as China and India, diets change dramatically and demand for animal protein - which requires lots of grain to produce - surges. Jordan estimates that 500 million to 800 million more residents of lower-income countries are shopping in food stores and eating in restaurants than a decade ago. He holds tractor maker Deere, fertilizer producer Mosaic and iPath DJ-UBS Grains, an exchange-traded note that tracks the price of corn, soybeans and wheat.

- Kiplinger's Personal Finance

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