SUSTAINED EXPANSION, From Alan D. Levenson, chief economist, T. Rowe Price
In the current environment, the flow of and interplay among recently-released economic data—and the stimulative thrust of monetary and fiscal policy—continue to suggest that the recovery, undisturbed by outside shocks, will soon evolve toward self-sustaining expansion. Business fixed investment advanced at a 2.9% annual rate in the final quarter of 2009, with a 13.3% advance in equipment spending outweighing a 15.4% contraction in outlay for structures. December gains in orders for and shipments of capital goods excluding defense and aircraft (+1.3% and +2.1%, respectively) provide strong quarter end momentum (+11.7% and +14.6% annualized vs. fourth quarter average, respectively) in support of current quarter growth prospects. More fundamentally, historically low levels of plant and equipment outlays relative to depreciation—a legacy of a sharp, cash-conserving suspension of investment plans in response to the seizing up of financial markets and freezing of economic activity in the fall of 2008—sets the stage for a catch-up expansion, and limits the scope for further retrenchment. A sharp slowing in the pace of inventory liquidation accounted for 3.4 percentage points of the fourth quarter advance in real GDP. An anticipated end to de-stocking, as evidenced in January readings from regional surveys of manufacturing conditions, would add a percentage point to current quarter growth. The scope for growth contribution from the accumulation phase may be more limited than during the rapid ending of liquidation, but low levels relative to sales support our expectation that inventory building will add roughly three-quarters of a percentage point over the course of this year, and all but rule out a significant or sustained drag on growth from business inventories in the near term.
Productivity was unusually resilient during the depth of the recession and has surged at a 7%-7.5% annual rate over the last three quarters. While strong productivity gains aren’t unusual in the early stages of recovery, neither are they sustainable. We believe that productivity growth is slowing markedly in the current quarter, and that net employment growth will commence by quarter’s end (we estimate that nonfarm payroll employment was unchanged in January). More broadly, outsized productivity gains over the past five quarters–dating to the intensification of the financial crisis in the fall of 2008–indicate that employers may have overshot the minimum employment levels required to meet a renormalized rate of demand. Put differently, even accepting a declining trend in employment per unit of GDP (rising trend in productivity), the combination of further headcount reduction and a rebound in output in the fourth quarter of last year left employment 1.2%, roughly 1.6 million jobs, below the trend ratio to the fourth quarter level of real GDP. This perspective imparts slight upside to our expectation that payrolls will add 1.2 million jobs this year, and reduces significantly the downside risks to headcounts should the recovery hiccup.
In short, the economy’s internal workings–including the need to shore up lean inventories, maintain stocks of plant and equipment, and bring workers back to meet rising demand–speak to the emergence of positive feedback loops that will take hold and gain momentum. The additional assumptions, unspoken but critical, are that policy makers will provide appropriate support, and that the forecast horizon will be free of adverse policy-related shocks.
Risks Remain in Emerging Markets, From Brent Jones, senior vice president and portfolio manager, GE Asset Management
While we believe that emerging markets offer a compelling case for investment in light of their improving fundamentals, they are not without risk. Their greater reward potential still comes with higher risk, as their corporate governance and other characteristics are not yet on par with developed markets. In addition, investors’ enthusiasm for the asset class should be tempered by the recognition that the recovery is still fragile. Policymakers may have averted a global depression and systemic collapse, but we believe there are rising prospects for a policy mistake to occur when stimulus and liquidity measures are eventually reined back in. If policymakers stop pumping money into the system too soon, it could trigger a reduction in economic growth. Yet extending the stimulus for too long risks the diversion of funds into stocks, property or other assets—and the potential for another “bubble” to form. For now, there are few signs of any policy shifts, particularly in developed markets where growth is currently weak, but if inflation expectations change or growth improves markedly, we believe uncertainty may rise over policy exit strategies, which may increase volatility across all markets. Although the contraction in developed economies appears to be over, they must still contend with deleveraging by consumers and corporations, more restrictive lending standards, rising savings rates and high unemployment.
We think these trends will likely restrain growth in consumption, particularly in the United States where the $10 trillion consumer market remains in retrenchment mode. For emerging Asia, including China, we believe this last factor is critical because their transition to consumer-driven economies will probably be slow and gradual, and marked by near-term dependence on exports. Thus, while developing economies have emerged as the engines of growth in this nascent recovery, their prospects for continued momentum may be dimmed if the recovery of the developed world takes longer than expected.
Bring the World To Your Portfolio, Standard and Poor’s
One of the largest and best performing international funds over the past five years is the Harbor International Fund which has a massive $25 billion in assets spread across 101 different holdings in all of its shares classes ($3.2 billion in this share class). It has returned an average of 8.76% annually over the past five years, more than double the return of the international developed market benchmark, and 14.28% a year since it was opened to individual investors in 2002. The fund says it targets "Europe, the Pacific Basin and emerging industrialized countries" with France and the United Kingdom its largest country allocations at the end of September 2009 at 18.3% and 14.9%, respectively. Financial services (about 22%) and energy (about 14%) represented the fund's top sector exposure. At the end of 2009, its top holdings were Brazil's national oil company Petroleo Brasileiro, Brazilian bank Banco Bradesco, and French financial services giant BNP Paribas. Its 1.19% expense ratio is about average.
Another large, well-performing fund is the Dodge and Cox International Stock Fund, which, with $36.7 billion invested in what it views as 101 "temporarily undervalued" stocks, is even larger than the Harbor fund. It returned an average of 5.59% annually over the past five years, and an average of 8.73% annually since it opened in May 2001. About 64% of the fund is invested in Europe, and financials are the fund's largest sector, with 21.5%, followed by consumer discretionary (16%) and information technology (12.2%). The fund's three top holdings are French cement maker Lafarge, South African media company Naspers and Swiss pharmaceutical company Novartis. Its 0.64% expense ratio is well below most of its peers.
Scout International Fund is smaller than the others, with about $5 billion invested in 96 stocks. Its 7.52% average annual return over the past five years and 9.27% since it opened in September 1993, are impressive. While the fund will invest in U.S. companies if their primary business lies outside the country, its U.S. allocation was only about 5% as of Sept. 30, 2009, the latest information available. At that time, its three top holdings were U.K. banking giant HSBC, Greece's Coca Cola Hellenic Bottling, and U.K. insurance provider Prudential PLC London. Lastly, the Oakmark International Fund has gathered about $4.4 billion investing in 62 stocks that "trade at a substantial discount to what the fund's managers consider to be their true business value, according to the Oakmark.
Report Calendar
Monday Feb. 1:
• Personal Incomes and Outlays, December
• ISM Manufacturing Index, January
• Construction Spending, December
• Corporate Earnings: Capital Bank [CBKN], First State Bancorp [FSNM], Flagstar Bancorp [FBC], Old National Bancorp [ONB], Pacific Capital Bancorp [PCBC], Peapack-Gladstone Financial Corp. [PGC], Sterling Bancorp [STL], Sterling Financial Corp. [STSA]
Tuesday Feb. 2:
• Domestic Motor Vehicle Sales, January
• Pending Home Sales Index, December
• Treasury Secretary Tim Geithner testifies before the Senate Finance Committee on the fiscal year 2011 budget
• Chair of the President’s Economic Recovery Advisory Board Paul Volcker testifies on regulations to limit high-risk bank activities before the Senate Finance Committee
• Corporate Earnings: Aflac Inc. [AFL], MetLife Inc. [MET]
Wednesday Feb. 3:
• Challenger Job-Cut Report, January
• Automatic Data Processing Employment Report, January
• Treasury Refunding Announcement
• ISM Non-Manufacturing Index, January
• Corporate Earnings: Ameriprise Financial [AMP], Fidelity National Financial [FNF], Pfizer [PFE], Selective Insurance Group, Inc. [SIGI], The Hanover Insurance Group, Inc. [THG], Time Warner Inc. [TWX], Visa Inc. [V]
Thursday Feb. 4:
• Monster Employment Index, January
• Jobless Claims, week of Jan. 30
• Productivity and Costs, fourth quarter 2009
• Factory Orders, December
• Corporate Earnings: Broadridge Financial Solutions [BR], Essex Property Trust [ESS], Mastercard Inc. [MA], Shinhan Financial Group Co. [SHG], Sony Corp. [SNE], Zurich Financial Services [ZIGO]
Friday Feb. 5
• Employment Situation, January
• Consumer Credit, December
• Corporate Earnings: Aetna Inc. [AET]
