Investors are being encouraged to step back into US equities amid expectations of record earnings growth next year and further signs of recovery in the domestic economy.
Speaking via teleconference from the US, Mike O’Rourke, chief market strategist for institutional brokerage and fund services firm BTIG, notes that US stocks only need 5% growth on top of this year’s forecast earnings to achieve record earnings in 2011.
“When this theme starts playing out, you will see the big institutional investors like pension funds and endowments, which have shied away from equities in the past few years in favour of fixed income, come back into the equity market,” he predicts.
Just a month ago, he notes, dividend yields for high-quality stocks were testing 10-year Treasury yields. “You have a combination of Treasuries being very expensive and equities being very attractive, and when you start talking about record levels of earnings, that will resonate with people. Despite the US’s challenges, you have to recognise it’s a real positive if you are buying stocks.”
O’Rourke expects an acceleration in US economic data to continue into 2011 and even to surprise on the upside. The International Monetary Fund (IMF) has estimated world GDP growth for 2010 at 4.77%, compared with a pre-crisis average of 3.99%, but O’Rourke is confident the IMF will need to raise its 4.2% global forecast for next year as more positive US economic data emerges.
“We are coming out of this global crisis with a lot of companies having reconfigured themselves and they are much better positioned to take advantage of the global growth story, especially in Asia,” he adds. “So that is a positive and one of the reasons that the US will get its 5% earnings growth next year. You will see investors being a lot more optimistic on equities here in the US.”
While the S&P500 has seen a 20% post-July rally, O’Rourke suggests this was driven by traders and speculators – primarily hedge funds – rather than investors, with equity exposures not having increased that much. “That is important because you always need additional buyers to come into the market.”
Further, he believes that inflation fears on the back of the US Federal Reserve’s QE2 programme are ill-conceived and have resulted in overtrading.
He points out that more than $1 trillion of the Fed’s $1.7 trillion in asset purchases from December 2008 to March 2010 wound up in excess bank reserves that ended up parked back at the Fed – increasing the monetary base but not creating additional growth in money supply.
“When people talk about inflation fears, the banks would have to be lending those reserves in order to fuel additional money supply growth, which would fuel inflation. But they’re not,” he states.
Nevertheless, commodity prices have risen as people bet on inflation, while the Fed has been buying US Treasuries and driving yields lower. The level of speculative long positions in most commodities recently approached record levels, notes O’Rourke.
“I think that is what has fuelled the run-up in commodity prices, investors making that adjustment process beforehand,” he says. “So I don’t expect inflation to materialise in the near term and I expect commodity prices to continue correcting because they‘ve gotten ahead of themselves on the back of QE. Likewise I expect treasury yields to rise and both these lines [see chart] to start converging, as they have in the past few weeks.”
It is not only in US equities that O’Rourke sees opportunities. He describes valuations for the Hang Seng Index at 14-15 times as “pretty fair, especially seeing as that is where the cornerstone of the growth is”.
With the Hong Kong dollar pegged to the US, “one of my concerns is if people believe the Fed’s policy is more stimulative than I expect it to be, that is an issue where prices tend to overshoot on the upside”.
“But price-to-book and price-to-earnings valuations are in the middle of the range, and considering that is where the global growth story is, I still think there is upside.”
He also sees valuations as extremely attractive for the S&P/ASX200 with Australia in line to benefit from the global growth story. He expects this to play out next year, with US dollar stability good for Aussie stocks and the strength of the Aussie dollar starting to abate.
He is more cautious, however, on low valuation multiples for the Stoxx Europe 600 because of the low-growth environment and challenges associated with heightened sovereign debt risk.