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Byron Wien: Reflections at Year-End

12-18 00:00 财经网 财经网

December 2013
By Byron Wien, Vice Chairman of Blackstone Advisory Partners LP

I think most investors would agree that as the year began they did not expect the Standard & Poor's 500 to have risen 27% by Thanksgiving.  Stocks have continually worked their way higher with the only meaningful corrections occurring in June, August and October when the talk of reducing the $85 billion a month monetary easing program picked up (June, August) and the government shut down (October).  All of this has taken place without the help of especially strong earnings or declining interest rates.  The U.S. economy has struggled to grow at 2% and the much-anticipated year-end acceleration has failed to materialize.  The individual investor has become less enchanted with bonds and has been buying stocks, but it has not yet become a tumultuous shift.  Corporations have been purchasing their own stock back, but nothing much beyond normal levels.  Washington continues to be dysfunctional so nothing has happened there to increase confidence.  Geopolitical issues have improved, but we are not yet at a point where we can feel comfortable about the Middle East, Europe or the South China Sea. 

I continue to believe that the monetary expansion of the Federal Reserve was a major factor in the appreciation of equities this year.  In my view, about three-quarters of the $85 billion a month of the bond-buying program flows into financial assets rather than the real economy, so the program is a very inefficient form of economic stimulation.  The main effect of the expansion is to move stock prices higher and keep interest rates low.  If you assume that of the $85 billion, 75% goes into financial assets, that's about $63 billion.  If 75% of that goes into equities that's $47 billion.  The average daily dollar volume for the New York Stock Exchange and the Nasdaq is about $34 billion.  Assuming 22 trading days a month that's $748 billion.  The $47 billion seems like a minor factor influencing the stock market, so it must be the confidence the monetary easing engenders that propels the market higher.  We saw a hint of that when Ben Bernanke said he was thinking of tapering and confidence declined.

Renewed confidence has been reflected in mutual fund flows.  Up until this year investors have been more favorable toward bond funds, but the strong performance of equities in 2012 and so far this year has changed the mood.  As a result, through October flows into U.S.-oriented equity mutual funds have been $20.2 billion and international equity funds have gotten $113 billion, while bond funds have experienced withdrawals of $39 billion.  Institutional investors also have been more willing to take the cash they have had in reserves and put it into equities.  The prevailing view seems to be that as long as monetary policy is accommodative, stocks will keep rising.  In the view of most investors, valuation is not yet a problem.  The S&P 500 is selling at less than sixteen times earnings, a long way from the excessive multiple levels of 2007 and 1999.  Fifteen times is the long-term average. 

There is fear that the good times will end when the Federal Reserve trims back its easing.  To me that does not seem likely to happen soon.  December will be Bernanke's last Federal Open Market Committee meeting and I do not think he plans a policy shift as his parting gesture.  Similarly, it is not likely that Janet Yellen changes the policy at her first meeting.  What happens when is dependent on how the economy is doing.  Unemployment is still above 7%; real GDP growth probably will not exceed 2.5% soon.  The economy still needs the modest amount of stimulus the Fed is providing, so a change of policy will not take place before the spring, in my opinion.    

It is probably useful to compare the present bull market to previous positive periods.  According to analytical work by Strategas Research, the typical bull market lasts 54 months and appreciates 136% from its trough.  Of this gain, 43 percentage points are accounted for by earnings improvement and 93 points are provided by multiple expansion.  This is because the typical bear market is caused by a tightening of monetary policy to control inflation resulting in rising interest rates.  As interest rates fall to combat the recession, price earnings ratios rise.  But that didn't happen this time.  The bear market of 2008-9 was caused by the sub-prime mortgage crisis and the recession it produced.  Interest rates were low when the decline started and they stayed low throughout the rise in the market.  In this cycle, which has lasted 56 months, the S&P 500 has risen 166% with 106 points coming from earnings improvement and only 59 points from multiple expansion.  Based on history, the current bull market is already aging and with most observers expecting interest rates to rise, there is not much chance for further multiple expansion.  These factors would argue for limited upside.
 
There is some better news on the earnings front.  While the U.S. economy has continued to plod along at a growth rate of 2%, and earnings and revenues for the S&P 500 had been increasing at 2% and 2.5% respectively, there has been some improvement since October.  Earnings and revenues are now increasing at 5% and 4%, respectively.  While this does not yet confirm the acceleration that many were expecting for the second half, it does reflect a more positive business environment.  Earnings for the S&P 500 for 2013 are running at a rate of about $105.  The consensus estimate for 2014 is about $120.  I have been skeptical about an increase of that magnitude with profit margins at a high and revenues increasing modestly, but if the present favorable trend continues, earnings may turn out to be stronger than I had thought. 

I was originally planning to write about the emerging markets this month.  Equities for these countries have been doing better since the summer, but overall, the performance in 2013 has been disappointing.  The economies are still growing, but their rate of growth has slowed down substantially and this has cooled off investor enthusiasm.  Their GDP is expanding faster than their developed country counterparts.  China is expected to grow at 7.4% in 2014, India at 4.5%, Brazil at 2.3% and Mexico at 3.5%.  Emerging markets are 45% of world GDP, however, and, in my view, they are going to increase their importance going forward.  The standard of living in these countries is rising in contrast to the developed world and that should provide numerous investment opportunities in the future.  It is just hard to know when these markets will start to perform again. 

There is reason to think important changes are taking place in China.  The November Third Plenum proposed a number of reforms.  The country is shifting toward market-driven pricing for fuel and pharmaceuticals rather than state control.  Eventually even the currency could float.  The one-child policy will be relaxed over time.  The hukou system, which deprived migrant workers of the ability to transfer social welfare benefits from their home town to their new place of employment, is in the process of change.  State-owned enterprises will set aside 30% of their profits for programs like social security and healthcare.  The result of these initiatives will be a shift in the balance of the economy from an export orientation to internal consumption.  Instead of providing favorably priced goods to the United States and buying our Treasury securities, China may become the most important customer for our manufactured products.  Xi Jinping, China's President, has the power and political base to make this happen.  Let's see how long it takes. 

After an initial surge of enthusiasm about the effects of Shinzo Abe's first two "arrows" of fiscal and monetary stimulus, investors have become skeptical about the third arrow which is a growth strategy based on deregulation, increased competitiveness and innovation.  The major impediment to the success of the growth plan is Japan's aging population and declining workforce.  Japanese real growth has averaged .8% for the past decade and the goal is to raise it to 2% in the future.  That may be hard to do based on Japan's traditional slowness in implementing reforms.  Right now according to the Japanese National Institute of Population and Social Security Research, Japan's working age population is set to fall from 82 million in 2010 (when the total population was 129 million) to 73 million in 2020 (when the total population will be 100 million).  It is hard to see how growth can increase with that demographic background.  Abe has already accomplished more than his critics thought he could, so perhaps further favorable surprises are ahead. 

At this point most observers believe that Syria will turn over its chemical weapons and that military action there will be unnecessary.  Bashar al-Assad will remain in power as a result, but that seems to be a price we are willing to pay, which is an enormous disappointment to the rebels who were fighting to overthrow his repressive and murderous regime.  A turn for the worse there could destabilize world markets.  The principal criticism of this plan is that it was proposed by Russia and puts that country back in a leadership position on the world stage in addition to leaving Assad in power.  Since Western heads of state view Vladimir Putin cautiously, this is seen as problematic, but not to the extent that it will prevent the chemical weapons surrender plan from proceeding, and it seems to be going well, so far.
 
Similarly, most investors believe that Iran is serious about its willingness to curtail its nuclear weapons development program.  There is reason to think that view is correct since the sanctions imposed on the country were clearly holding back economic development and depriving the population of a better quality of life.  But Benjamin Netanyahu believes the deal is an "historic mistake" and Iran is deceiving na?ve Westerners.  It is probably wrong to be complacent about the potential success of the Iran agreement, but it is better than the threatening situation that existed before and worth a six-month try.  The main criticism of the Iran deal is that the sanctions were working well and Western leaders should have settled for nothing short of a total suspension of the Iranian nuclear program.  By letting the Iranians continue to enrich uranium, albeit not to the weapons grade level, they will be in a position to produce a bomb within a short period if the limits on their efforts are ever suspended for any reason.  If Iran had a nuclear weapon the entire region would be destabilized.
 
Back at home we have the unfortunate rollout of the Affordable Care Act.  There is no question that it was a serious failure and its lasting implications depend on how rapidly it can be fixed.  I continue to believe that the major problem with the Act will be its cost to both the individual participant and the Federal government.  It is unrealistic to assume that you can insure more than 40 million people without Washington providing significant financial support.  The success or failure of this program is clearly going to be a key issue in the Congressional elections in 2014.

As an aside, I traveled to Myanmar (Burma) during November.  It is one of the world's true wonders.  The temples and stupas of Bagan are breathtaking and rank with Angkor Wat in Cambodia.  Inle Lake with its communities of houses on stilts is something to see.  It gives someone in our business perspective to see thousands of people living on several dollars a day.  Don't worry about having to get there tomorrow.  The major cities like Yangon and Mandalay may change but the principal areas of interest have been that way for hundreds of years and, aside from the hoards of tourists already there, are likely to remain that way for a long time.
 
We have reached that time in the year where everyone is speculating about the prospects for equities in the year ahead.  As usual the consensus is that the market will be up 10% in 2014.  I have been an observer of strategists' estimates for half a century and I can tell you that as a group they always think the market will be up 10% in the following year whether stocks were up 20% or down 20% in the previous year.  What nobody seems to be talking about is the possibility of a "fat tail."  With the uncertainties surrounding Obama's Affordable Care Act, and the risks of the initiatives in Syria and Iran taking a turn for the worse, profit margins peaking and earnings falling short, the downside is certainly not out of the question.  As for the positives, the tone of economies around the world is improving, individuals are coming back into the equity market, share buy-backs continue, merger and acquisition activity is picking up, growth in Europe is getting better, the decline in oil prices increasing consumer purchasing power and interest rates are likely to stay low because of a reduction in bond offerings.  This could produce another year of strong stock market gains.  At this point I don't know which of the "fat tails" is more likely.  While investor optimism is approaching extreme levels on the positive side, which is a warning signal, stocks don't appear to be melting up yet.  I just have a feeling that 10% appreciation won't be the number at year-end 2014.
 

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