One needs to be careful about getting too abstract when talking about investments, but in trying to get a grasp of where the financial markets have gone this year, and where they're headed in 2011, you can't help but sense that at least two realities are at play.
Domestically, the stark reality is that unemployment remains stuck at just under 10%, with corporations showing no signs of expanding payrolls or wages to a degree that would spark robust economic growth. The nation's housing and foreclosure problems, meanwhile, are entering into a fourth year, muting a recovery that is sputtering along at 2% per year. The gloom surrounding the U.S. economy is the primary reason why investors-both individual and institutional-are keeping an abnormally high portion of their assets on the sidelines, despite favorable market returns, earnings outlooks and valuations, according to investment managers.
When you step back and take in a broader view, however, things are happening that give many in the investment community reason for optimism and, in some cases, bullishness. This outlook starts with corporate earnings, which have shattered most analysts' forecasts in 2010 and been perhaps the primary reason the market is yielding double-digit returns year-to-date (the S&P 500 was up 10.7% as of November 9). The earnings picture is one of the most notable silver linings of the 2008 market collapse, as corporations responded to the crisis by cutting costs, reducing debt and aggressively pursuing global markets that are now growing at twice the rate of the U.S. economy. The trend is part of a seismic shift in the investing landscape that has seen a broad cross-section of U.S. managers move their focus overseas-to U.S.-based companies with a sizable presence in foreign markets as well as foreign companies.
These certainly aren't the only factors shaping the outlook of investors. Much concern centers on the Federal Reserve, which is embarking on a plan to buy $600 billion in government bonds-an unprecedented economic engineering initiative designed to stimulate the U.S. economy at the risk, some say, of igniting runaway inflation.
Pockets of activity that provided investors with some relief, such as emerging markets and real estate, will also be closely watched, as will merger and acquisition activity, which managers say has noticeably increased this year. As opposed to the spring, when dire warnings of a double-dip recession paralyzed investors, they note that many indicators are headed in the right direction, albeit slowly.
Yet the prevailing questions heading into the new year seem to be centered on which sentiment will prevail in 2011: the feeling that the domestic market is too weak for equity investing or the argument that, when looked at globally, the equity market is poised for a bull run.
"The claws of the bear are still in the hearts of investors," says David Winters, manager of the Wintergreen Fund. "I think that people are still very much trapped by what happened in 2008 and are not willing to take any market fluctuation. They would much rather have no return than a negative return."
Going Global
The market dichotomy is a reflection of the extent to which U.S. corporations have become globalized, says Douglas Cote, senior portfolio manager for ING Investment Management. If investors were fully aware of how immersed U.S. companies have become in both emerging and developed overseas markets, they wouldn't be sitting on the sidelines as they are now, he says.
He feels that the investor who in past years was 60% equities and 40% fixed income has retreated into an 80% fixed-income position-a posture Cote feels is dangerous, particularly with the Fed planning to further loosen up the money supply.
Given the global economic growth rate, which averages out to about 4%, investors should be at least back to the 60/40 allocation, he says. "If you actually look at the facts, you would be bullish. If you look at the market from a global perspective, you would be bullish," Cote says.
The numbers vary based on the metrics used, but analysts estimate that S&P 500 companies derive anywhere between a third and a half of their revenues from international markets. While investors may not be highly aware of this fact, international managers have been highly aware of it as they've looked for alternatives to the ailing domestic economy over the past few years.
Given the question marks surrounding U.S. economic growth, investors cannot only expect to see managers bulk up on U.S. companies with international exposure, but also on companies that are domiciled outside of the U.S.