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How long can this last? The U.S. stock market is out performing the world

posted on March 19, 2010 at 8:30 am
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economic recovery

I can think of a dozen reasons why in the long term U.S. stocks will underperform stocks in China, Brazil, India, Canada may be even Norway, South Africa, Germany, and Turkey. Huge government debt, highly leveraged consumers, under-investment in infrastructure, a lagging educational system, rising interest rates, a small and (in industries such as autos) uncompetitive manufacturing sector, out of control healthcare costs… Do I need to go on?

But in the next three to six months, I can’t think of a better stock market in the world for my money. China? Beijing is raising interest rates and shrinking the money supply. Brazil? Rate increases and all the uncertainty that comes with a close presidential election. India climbing inflation and interest rates.

In contrast, the United States looks like it’s in for stable interest rates. Inflation just high enough to take worries about deflation off the table. Easy year to year corporate earnings comparisons with the first half of 2009.

Hey, I still think the excrement is likely to hit the whirling blades in the last quarter of 2010 or early in 2011, but in the short-run the U.S. stock market looks, comparatively, like the best bet in the world for equities. I’m not saying the U.S. market and economy are perfect or wonderful—just that for this period they look better than the other guys.

Not so fabulous that I want to go out and bet the farm on U.S. stocks, but good enough so that I might want to add a dash of U.S. stock to my portfolio for the next quarter or two. Not so attractive for the long run that I want to tear up my long-term plan to over-weight developing market equities. Over five to ten years I think stocks from China and Brazil and the rest of the developing world will leave U.S. stocks—and even more so stocks from other developed economies–wallowing in their dust. But attractive enough in the short-run that putting some cash to work in U.S. stocks makes sense.

After my sell of GulfMark (GLF) on March 10, Jubak’s Picks is up to 14% in cash. I’m going to put some of that to work with a buy at the end of this column. And I’ll give you two more potential buys if you’ve got more cash on the sidelines than I do in your portfolio.

One of the lessons that the bear markets of 2000 and 2007 should have taught us is that investors need to think both long and short term. It’s not enough to put your money behind a great long term stock and then forget about it, lulled into complacency by a belief that in the long run your investments will do fine. In the short-run, we’ve learned even the best long run stocks can take beatings so horrible that most investors can’t hold on for the turnaround.

Google (GOOG), for example, is in my opinion a great long-term investment. But that doesn’t mean you could just buy and forget about it in the last five years or so. Look at this volatility:

On September 30, 2005 Google sold for $316 a share.

By October 1, 2007 it was at $583 and you were up 84%.

By November 24, 2008, it was down to $257 and you were down 56% from October 2007 and even down 19% from September 2005.

On March 16, 2009, the stock was back to $565. And an investor was either up 120% from November 2008, or down 3% from October 2007 or up 79% from September 2005.

I’m not saying that you had to trade Google during these market ups and downs in the hope of catching the tops and bottoms. But you sure could have used tools as time-honored as dollar-cost averaging (to buy more when shares are cheap and less when they’re expensive), or growth at a reasonable price (to sell some of your position when the stock is trading at a high price-to-earnings to growth rate (PEG) ratio and buying when Google’s growth was relatively cheaper) or good old portfolio rebalancing (to trim big positions) or by-the-book portfolio diversification (to keep the asset classes you own in balance) or even some macro-economic timing (to sell when the economy for advertising, Google’s main product after all, soured and to buy on prospects for recovery.)

Anything that might have leveled out some of the volatility and increased your sense that you had some control over your portfolio. Feeling like you can’t do anything that matters leads to panic and then, frequently, to selling in despair at the bottom. If all that your strategy does is help you hang on in the short-term through the volatility so that you actually reap those long term rewards, then that strategy is working for you.

Same with a market like this one that’s constantly setting out the punch bowl and then taking it away. The short-term rallies and reversals, the head-fakes and the bear traps are enough to drive you either out of the market totally because it’s just too frustrating or to gradually entice you into taking on more risk than you should out of frustration. I want you to stay in the market for the long run without taking on more risk than you should, and I want you to pay attention to what’s expensive and what’s not and to the balance in your portfolio even when volatility is driving you crazy.

Oddly enough I think focusing some attention and a little bit of money on the short-term is exactly how to keep from blowing up your long term strategy out of frustration. (I suggested this same kind of short-term/long-term thinking for income investors in my post http://jubakpicks.com/2010/03/05/how-to-maximize-what-your-cash-pays-even-when-nothing-is-paying-much-of-anything-now/ )

How frustrating is this stock market right now?

Think about 2009 when everybody was saying that China’s stock were the great long-term growth story of our time. (I agree—mostly. I do prefer some other developing markets to China but China is, in my opinion, an amazing growth story for the next decade or two. For what countries I prefer to China see my http://jubakpicks.com/2010/02/05/how-to-build-a-global-portfolio-what-countries-do-you-want-to-own/ )

And this year? Blah! (A highly technical financial term. Sorry to use jargon but sometimes it’s necessary.)

The iShares FTSE/Xinhua China 25 ETF (FXI), which tracks 25 of China’s biggest companies, was down 5% for 2010 as of March 16. The Shanghai Composite Index was down 9.2% for 2010—and that’s after rallying from the February low.

And the much reviled—and over the long-term perhaps justly scorned—U.S. stock market? The Standard & Poor’s 500 Stock Index was up 2.3% for the year as of March 16. (And up 10% from the February 8 low.)

That’s not a huge gain but remember we’re talking about what’s likely to be a really tough year for stocks—if the U.S. stock indexes deliver 10%, I’d be ecstatic—and we’re talking about not just absolute but comparative performance. That piddling 2.3% gain on the S&P 500 is a huge 11.5 percentage points above the loss delivered by the Shanghai market this year.

I think there are good reasons to expect that this out performance will continue for somewhere between three and six months.

Do the comparisons and you’ll see why.

  • On March 16 the Federal Reserve’s Open Market Committee renewed its promise to keep interest rates at the current 0% to 0.25% target for an “extended period.” China could raise interest rates as early as April. Brazil will raise rates this year. So will India.
  • U.S. inflation isn’t headed anywhere in the short-run. U.S. inflation rose at an annual rate of 2.6% in January (We get February numbers on March 18). More important than the absolute number is the direction. U.S. inflation was down from 2.7% in December. In China, on the other hand, inflation spiked to 2.7% in February. That’s after dropping to 1.5% in January from 1.7% in December. It’s always dangerous to rely too much on any economic numbers that include China’s week-long New Year holiday, but the size of the jump here clearly worried Chinese leaders who made the need to fight inflation a key point in their speeches at the recently concluded National People’s Congress.
  • The Fed isn’t moving to remove stimulus from the financial markets with anything like the speed that the authorities in Beijing are. So far the Fed has decided to stop pumping more liquidity into such markets as that for mortgage-backed securities, but it isn’t actually yet taking steps to pull money out. (For what the Fed has said so far on this see my post http://jubakpicks.com/2010/03/16/fed-holds-interest-rates-near-0-but-continues-to-reduce-role-in-the-markets/ )  China, on the other hand, has already started to increase the reserves that banks must keep with the People’s Bank of China.
  • The U.S. economy is the only game in town if China slows. If growth in China drops to, say 7% from the 10.7% th3 country recorded in the fourth quarter, its stock market will tumble. And so will the stock market of every other developing economy. They’re all seen as dependent on China’s rate of growth. (Why this should be seen as true for India escapes me, but the Indian market moves with China’s.) U.S. stocks won’t jump for joy but the U.S. economy is one of the world’s least dependent on exports and the U.S. domestic market is so large that it isn’t as strongly correlated with China’s economy as, say, Brazil is.
  • Finally, the U.S. economy is out of sync with the economies of the developing world. For much of 2009 that was a handicap as growth picked up in the economies of developing Asia much faster than it did for the U.S. economy. Now the U.S. still accelerating (probably) while the governments of China, India, Brazil, etc. are looking to cool growth in those economies. The U.S., of course, isn’t going to grow as fast as even a slowing China, but since stocks trade on expectations, the direction of any change in growth rate is more important at this point than the absolute rate itself.

This comparison doesn’t guarantee the out performance of the U.S. market in the short term. As I pointed out in my latest revision of “How to worry” ( http://jubakpicks.com/2010/02/16/how-to-worry-and-when-in-2010/ ), an unexpected slowdown in U.S. growth in the first quarter—to be reported in late April—would almost certainly stop any U.S. rally dead in its tracks. But short of that kind of surprise, I think the U.S. stock market is the best in the world for three to six months.

So what stocks would I look to add to my portfolio if I needed to add just a bit more U.S. spice to the stew?

I’ve got three suggestions.

Fluor (FLR). The engineering and construction company recently cut its guidance for 2010. Order backlogs been on a downward trend through 2009. And the company reports that customers are still reluctant to sign on for work. All this means that Fluor is ideally positioned to take advantage of an improving U.S. economy where industries such as the utility sector have huge backlogs of work that they put off in the down turn.

Metropolitan Life (MET). The company has just purchased American Life Insurance (ALICO) from American International Group (AIG). This purchase of one of the international crown jewels in the American International Group portfolio is Metropolitan Life’s reward for playing it conservatively in the run up to the financial crisis. Metropolitan Life is getting ALICO for a price that’s roughly in line with that of a U.S. life insurer but ALICO’s growth rate and opportunities are much greater given the company’s position in China, India, and the rest of Asia.

Union Pacific (UNP). As Warren Buffett said when he bought all of Burlington Northern Santa Fe, a rail road, especially one of the few transcontinental North American railroads is a bet on the U.S. economy.

Which one to buy? If you’re pretty much fully invested and just want to try to add a bit of U.S. dash to your portfolio, go with the stock with the most momentum in this group, Union Pacific. I’m adding that to Jubak’s Picks today. I’ll post a more detailed buy later today.

If you’re looking for more of a value play that might take longer to generate momentum, go with Fluor. Metropolitan Life should rebound with the U.S. financial sector as a whole so if you think you’re underexposed to that sector, it’s a good choice. Both Fluor and Metropolitan Life has enough exposure overseas to give them some legs when U.S. stocks start to fade.

I’m going to add these last two, Fluor and Metropolitan Life, to Jim’s Watch List with this post.

Full disclosure: I don’t own shares of any company mentioned in this post.

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24 comments

  • VSA on 19 March 2010

    Jim, your best article till date.. atleast for me.. as I have been struggling to make sense of this market since I started investing (for about an year).. i had been asking questions aronud this topic in comments sections.. and got great replies from catengineer and run… and now I get a full blown analysis and article from you.. your timing is perfect! :)

  • ANelson on 19 March 2010

    Jim,

    Thanks for all your help.

    Any more thoughts on Mxwl? Just seems to be going down, but has there been any major shift in how things are for Mxwl, or should we just be patient.

    Thanks again

    PS EdMgon….keep writing, and ignore the negative people.

  • catengineer on 19 March 2010

    I think that FLR is the only one of these that is fairly priced. I’m going to keep an eye on it today. MET has a great story, I’ll look to add it when it comes down a bit.

  • Run26.2 on 19 March 2010

    Related to UNP… JPMorgan sees better profits for railroads:

    http://www.marketwatch.com/story/jp-morgan-sees-better-profits-for-railroads-2010-03-19

  • Domino412 on 19 March 2010

    Fantastic column and very reassuring and calming , especially today. I have to say I am very frustrated with this market. I have darted in and out since the rally began last Spring, missing much of the big gains, but making a small pentance. What makes it so annoying is trying to perform as well as I did in 2006-2008. I made a boatload, and I guess I want to do it again. Better safe than sorry.

  • rolfer1 on 19 March 2010

    Jim,
    Thanks, as always, for the cogent analysis. Of the stocks you mentioned, FLR seems reasonably priced.

    You’ve also neatly turned a negative into a positive – “the U.S. economy is one of the world’s least dependent on exports”. And I agree that the US stock market is, for the (very short) time being, the least of all evil alternatives. But, you’ve also convincingly argued that the American consumer has changed its stripes and will reign in (profligate) spending.

    So, we have an economy with relatively little export power and a consumer that may continue to pull back on spending, thus negatively affecting 70% of our economy/GDP. We also have a stock market trading up on low volume with the rally broadening to riskier assets.

    IMO – emerging markets increasing rates is a long-term positive that will constrain speculation and will support continued growth in the BRICs allowing their stocks to rise faster on better footing than stocks in US markets. As a contrarian investor, I will look to buy emerging market stocks and indexes should your predicted drop, based on a China slowdown, occur.

  • leszek on 19 March 2010

    ANelson – MXWL was downgraded from hold to sell yesterday by Thomson Financial – Gradient. Hence the selloff in that stock.

    I’m using this weakness to pick up more.

  • mdistasio on 19 March 2010

    Would this mean its a great oppurtunity to buy ABV? It’s been down since Jim’s pick.

  • bruceonvashon on 19 March 2010

    Jim: The US Stock market is ouly outpreforming the world if you trade in dollars. If you convert the recent changes to euros, the market is just OK. In fact many of the swings in the last six months can be explaned by currency conversions and changes in the US Dollar. This does not fare well for fixed income or interest bearing accounts.

  • RM on 19 March 2010

    ANelson,
    I am with you on EdMcGon.
    I am new at ‘investing’ and I ‘attend’ this free ‘online’ classroom’ everyday. I am learning a lot from Mr. Jubak and all the posters here – thank you all! I have to say that without EdMcGon’s contributions, it has been a dull classroom. True learning comes from diverse, challenging ideas. Besides, all fields of knowledge/endeavor are interdependent of each other.
    Note: I am probably one of many ‘students’ here who do not really post.

    EdMcGon,
    You cannot allow the negative critics chase you out of this site. Like I said in an earlier post, this is Mr. Jubak’s site – he should be the one and only one who can judge/dismiss a poster and his/her opinions.

    STL – you disappeared too!

    Have a good day everyone!

  • cyfairslam on 19 March 2010

    I think we all are going to be able to buy US stocks cheaper later this year.

    I will keep my cash for a while.

  • Run26.2 on 19 March 2010

    From wsj.com:

    “In an unscheduled move on Friday the Reserve Bank of India raised the repurchase rate, or its key lending rate, to 5% and the reverse repurchase rate, or the borrowing rate, to 3.50% with immediate effect.”

  • RM on 19 March 2010

    Mr. Jubak,
    Off– topic, but… does below Barron’s article impact your recent assessment of Transocean?
    Thanks.
    “Trade Deepwater Rigs for Energy Services http://online.barrons.com/article/SB126886036351663677.html?mod=BOL_hps_oe
    Credit Suisse likes Halliburton and Schlumberger.

    RECENT CONTRACT ACTIVITY plus anecdotal commentary from contractors suggest that the deepwater-rig market is hitting an “air pocket” faster than we anticipated. As such, we are reducing our earnings-per-share estimates and target prices to incorporate lower day rate and utilization forecasts. Our 2010 and 2011 EPS estimates are 6% and 14% below consensus, respectively……”

  • flgator on 19 March 2010

    anyone else picking up some MXWL on this dip (about 1/2 of Jim’s target price)?

  • marsdon1201 on 19 March 2010

    Midistasio,
    After Jim’s buy rec. of ABV it did go down. Picked some up at 91, looking to buy more if it fall to that area again. It just had it’s ex date for recent dividend, Mar. 19.

  • andante on 19 March 2010

    EdMcGon
    The Brazil-US-WTO cotton flare up appears to be going to negotiation. But now Graham and Schumer are in the kitchen cooking on their own Smoot-Hawley redux. Even the IMF has weighed in on this one.

  • catengineer on 19 March 2010

    Funny….this morning I thought that if FLR was $1 cheaper I’d jump in. It’s now $.75 cheaper…close enough. I’ve been sitting on the sidelines for quite some time now so I’m in!!

  • andante on 19 March 2010

    Keep your broomsticks handy, quadruple-witching today.

  • andante on 19 March 2010

    Even CERN is working on a black hole with their Large Haydron Collider in Geneva. Seems they got it up to speed today for quadruple-witching.

  • crabbyjim on 19 March 2010

    Better safe than sorry.
    In reply to post by Domino412 (3/19), who is frustrated because he hasn’t had good investing results over the past year. Sorry, but you missed an opportunity to make another boatload. Pick up a Barron’s this weekend and check the 52 week high-low prices for the past year. There were innumerable opportunities to double, triple, quadruple – or more, your money in some very fine companies, and many of them were paying good dividends the entire time. Or what’ wrong with buying Ford at less than $2.00 and riding it up to its present $13+? Or a fine company like Johnson Controls (JCI) – from $9.00 to $32.00, and it is still a good buy. You like Las Vegas? How about Las Vegas Sands – $2.00 to $22.00, and then having the agony of deciding whether or not to cash in your chips. Was Jim recommending MetLife when it was $14.00 a share? It is now $42.00, and also a good buy. You and Jim can have China – I will continue to bet on well managed American Companies. There are plenty of them and many of them are still bargains. Buy some ANH and collect almost 17% in dividends while you wait for the price to go up. Buy some PKI , a great company and a very likely purchase for some larger company -

  • crabbyjim on 19 March 2010

    Somehow my message got posted before I was finished. PKI is a very likely buyout in the not too distant future. If you do want to spread your money around the world, Banco Santander (STD), which has more than doubled this past year, is still a great buy – and pays almost a 4% dividend. You apparently sat out a great year. I think 2010 can be a good year too. If nowhere else, you can start with Microsoft. There should be at least a $10 profit there, and a possible dividend boost.

  • cjxland on 20 March 2010

    As this seems to be the Friday Free-For-All, I will also weigh in- fwiw, and off-topic- on whom-all can or should post comments here: I’ll side with the laissez faires… more or less.

    I read Jim’s articles for his insight, expertise, experience, and far better research than I can muster personally, and for a sort of ongoing follow-up to his book. I don’t invest in exactly his way, but I greatly appreciate his thoughts on all topics, and I like a lot of his ideas.

    I prefer that the comments posted to Jim’s articles remain on topic- in general- and avoid most politics; there are plenty of other sites to vent yer personal political opinions. But if someone wants to blog away here on his own investing strategy, fine portfolio performance or brilliant stock picking, it is not my concern- I peruse the comments for the humour content, if at all. I’m here to read Jim.

    So let the others blog away as they wish [Jim's articles are "blogs" in only the same sense that Lafite Rothschild is just a bottle of wine.] I do note that there are several folks who seem to be in need of pretty basic investment advice, or want someone to give them specific hot tips; personally, I’d stick with the master rather than the students- or at very least, as my Dad the pilot used to say, you better know who you are flying with.

  • Narda on 20 March 2010

    So you would looking in June to start moving to cash to be ready for the humdinger of a 4th quarter?

  • dmonnie on 20 March 2010

    agree ….us market safest bet for now
    many co’s still cheap
    msft . intc . aa . bpsg . adm . ebix ( very cheap )
    nice article

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