Global stock markets ended 2010 with a flourish, with December returns for the MSCI World index averaging over 7% in U.S. dollar terms, making last month the best December since 1999. We note this with some trepidation since who can forget what followed December 1999. But stock prices have much more fundamental support today than they did as the dot.com bubble was about to burst 11 years ago. For one thing, the market multiple – the forward P/E on the S&P 500 – is in the 13-14 range currently, not much more than half its level in 1999. That is not to say that, after an 86% rise in the S&P 500 over the past 22 months, there is little downside risk facing stock investors as the New Year dawns. In terms of addressing the long-term deficits and imbalances that plague the developed economies of Europe and the U.S., policy makers have so far done a good job of deferring the hard decisions – kicking the can down the road, as many have described the policy treatment to date. While the markets appear to reflect a growing confidence that problems will be overcome, at some point the fiscal and monetary stimulus has to end and the economy has to grow on its own.
The fourth quarter and the past month in particular brought a spate of positive economic indications, powering the major stock market averages to 27-month highs in the final hours of 2010. Along with other signs of improving health in the money and securities markets, the year-end highs in stock prices seem to suggest that the global financial system is returning to a more normal condition. We are certainly not back to Normal, with a capital N (if there really is such a place), as a look at world labor markets clearly illustrates. The big rise in corporate profit margins over the past two years cannot be sustained without at least some corresponding improvement in wage and salary income, something decidedly lacking so far in the economic recovery. We suspect that 2011 will bring some evidence of better returns to labor, a prerequisite in our view for the recovery transforming itself into genuine expansion. At the same time, the year ahead is sure to have periods like the spring and summer of 2010, when the economic and market indicators are not so promising. At such times, it may be helpful to remember the 2010 experience and to realize that not even the most enduring trend continues in a straight line.
INVESTMENT OUTLOOK…Despite the fourth quarter’s escalation in inflation expectations and bond market volatility, a respectable year-end rally in stocks was fashioned out of improvement in leading economic indicators and, in the United States, perhaps a sense that the two parties in Washington may be able to accomplish something positive in 2011. It is important to remember that at some point the U.S. economy will have to do without the trillion dollar stimulus packages – past and prospective – that have been contributing to the quickening seen in economic activity. In the end, strong corporate earnings can overcome a lot of this market’s shortcomings, and we judge the profits outlook for 2011 to be good. With respect to bonds, we are not completely comfortable with the near unanimity reflected in the markets during the fourth quarter that interest rates can only go higher in 2011.
Copyright © 2011 by Wright Investors’ Service, Inc.