Before I get started here I'd like to thank PIMCO Funds for a lot of great research and information. A lot of the charts that I am going to use today come from their research. I was fortunate to have been invited to their Due Diligence meeting at their world headquarters in Newport Beach California last week.
Where is the global economy headed? Take a look at this map from the International Monetary Fund.
As you can see the projected GDP growth for all of North America is between zero and 3%. Much of Europe is projected to do zero to 3% as well with the exception of the PIGs (Portugal, Italy, Greece, and Spain). Those economies are all in negative territory to one degree or another.
Now notice south of our border. All of Mexico, Central America, and South America; with the exception of Paraguay, are projected to grow at 3-6% according to the IMF. So as you can see, starting with the big picture, this map can give us clues as to where growth opportunities may lie in the world.
Now Let's Narrow the Focus
Let's take a look at the US. What might we expect going forward here? What effect might the election have? Let's first take a look at the projections of the Federal Reserve.
The Fed has been very clear that they have given up all pretense of controlling inflation at this point in favor of creating jobs. While their stated inflation target is 2%, if they really expect to hit their nominal GDP targets of 5%, that indicates to me that the Fed is willing to accept significantly higher inflation to help them reach their targets.
Why do I say that? Because if you look you'll see that their targets include 3% real GDP growth. Right now real GDP is only 2/3 of what they are projecting so they need the additional inflation to make up the difference.
What Is Stopping US?
The US is suffering through one of the weakest recoveries in history. What are some of the things that are holding us back? As we've written in the past, we need companies to start experiencing growth, which leads to hiring, which leads to more consumer spending. Housing needs to heal because it is the thing in most people's lives that causes them to spend, that and children. Take a look at these 3 charts.
As you can see in the Household Net Worth chart, even though the stock market has recovered quite a bit of its losses, because of the losses in real estate household net worth has only recovered about 50% of what was lost since 2007. That means Americans still aren't feeling as prosperous as they used to which leads to them still not spending as much as they used to.
The second chart shows that average hourly earnings continue to decline. That again, in our opinion, makes consumers less likely to spend. In 2000 through 2003 you can see that earnings were declining just like what we have been going through the last few years. The difference between then and now is that back then the value of their houses continued to skyrocket. That meant that even though they weren't making as much they could simply borrow the equity out of their houses to spend. Today many people don't have that option. And those that do have that option aren't as inclined to spend either because they don't want to end up like their friends and relatives.
So What Does That Mean For US Markets?
Great question because as we know the economy and the markets are two different things. While we are going through one of the weakest recoveries in history, the market, at this point, has done relatively well. Now that can change in a hurry but at least at this point it has done well.
One thing that can give us a clue is what is the current valuation? Are stocks cheap or expensive right now? Why does that matter? Because in normal times stocks tend to be cheap at the beginning of rallies and tend to become more and more expensive as the rally continues until it reaches a point where the rally stalls or even reverses. So where are stock valuations now?
According to Dr. Robert Shiller of Yale, as of June 30, 2012, stocks were trading at 21X earnings which is significantly higher than the average of 16x. In fact, to get back down to 16x would be a -22% correction. (Source:
http://www.econ.yale.edu/~shiller/)
This next chart takes a look at what PIMCO views as the strengths and weaknesses of the markets going forward.
What About The Averages?
A couple of weeks ago we wrote about the false expectations that averages can create. With the recent run up in the stock market, many are asking if we are back to the 10% per year averages that a lot of studies have led Americans to expect over the long term. That's a good question.
PIMCO has their view which I happen to agree with. You may have read about it. Bill Gross, PIMCOs founder, calls it the "new normal". PIMCO expects bonds to average about 2% per year going forward and equities to average between 4-5% going forward.
Dr. Shiller from Yale is only slightly more bullish. He expects equities to return around 6% going forward. That is still a far cry from the 10% that a lot of people expect long term. Here are his calculations that show how he arrives at that number.
But What About the Election and the 2013 Fiscal Cliff?
Now I've got a lot more to share with you next week. We will be taking a look at risk from a different angle than most are used to. I'll also be sharing some info from Mark Kiesel's presentation called Diamonds in the Rough. You're not going to want to miss that. Mark shares some great insights into industries that he thinks offer real promise. Here is an example.
(Disclosure: I am not making a recommendation for or against either of these companies. They just help to illustrate an interesting development in the gaming industry)
I will explain the story behind this chart next week!
Now back to the question of politics. One of the biggest threats facing the US economically is the 2013 Fiscal Cliff. So PIMCO has put a lot of time into evaluating the "what if" scenarios. What really surprised me was that the difference in drag on GDP between the different scenarios was really minimal.
Whether it is Obama Presidency-Split Congress, Obama Presidency-Republican Congress, Romney Presidency-Republican Congress, or Obama Presidency-Democrat Congress; the difference is only 20 basis points. That's .20%! Take a look.
Some Interesting Opportunities Going Forward
Folks we think there are some really interesting opportunities developing right now. As I mentioned above, next week we will be looking at some new strategies and ideas to take advantage of the opportunities that we see developing.
Until next week , Protect Your Wealth!