There’s enough headwind at the global macro-economic level for equity investors. Why?
1. For starters, the 50 bps cut in the U.S. dollar swap rate is another steroid (in a long series) for the structurally ailing eurozone. The 3 month LIBOR OIS spread has been steadily climbing since July this year, reminiscent of the run-up in 2008. Now at 43 bps, the spread has doubled in less than 16 weeks. Clearly, some short term action was needed to prevent a liquidity freeze in the European Inter-bank market, while the political wrangling continues. How long this will keep the patient alive is anybody’s guess. The low-level fiscal consolidation now being discussed is probably long overdue and inadequate, given the spectre of low base-case growth rates across the eurozone and recent rapid widening of yield spreads on PIIGS issuances.
2. Meanwhile, a series of ratings downgrades have begun to hit us with gut-wrenching regularity. Hungary, eurozone banks, U.S. top tier banks... the list is growing. To some extent, recent ratings downgrades are a delayed barometer of the degree of risk congregating in the banking sector since the credit crisis broke loose. Even emerging markets haven’t been spared. Moody’s recently downgraded its outlook on Indian banks to ‘negative’. The downgrade for U.S. banks would signal an imminent increase in borrowing costs and more collateral calls on derivative and repo exposures.
3. The U.S. economy isn’t out of the woods by a long shot. Civilian unemployment rate is stubbornly anchored to the 9% mark, and while today’s jobs data points to a marginal decline in the headline number, there’s a steep hill to climb. Consumer de-leveraging continues and economists have indicated that current persistent unemployment in the U.S. is less cyclical and more structural (meaning: don’t expect sustained directional changes anytime soon).
4. Recent data on speculative grade bond spreads and rating actions aren’t rosy either. An S&P report published in November highlighted the impact of stresses caused by a jobless ‘recovery’ and high budget deficits within the U.S. economy. In the non-financial sector, key indicators such as ratio of downgrades to upgrades, speculative-grade bond spreads and distress ratio (number of distressed securities to total speculative grade issuances) are indicative of stress in credit markets. The distress ratio alone is up 5% month on month as of October 2011. The recent ratings downgrades in the financial sector aren’t likely to help.
Yet, for the value investor, there is sufficient silver lining. The S & P 500 currently trades at less than 14 times P/E, significantly less than over a year ago and below historic average. As an emerging market equity investor, I took an outsider's view at the top ten companies in the S&P 100 (in terms of market capitalization) and found the data compelling. By the way, most of these companies are also on the top 10 S&P 500 value index. The S&P 100 is a sub-set of the S&P 500, and measures the performance of blue-chip U.S. companies:
|Stock||Symbol||Sector||% of Foreign Sales||Forward P/E||Implied 5 year growth rate||Fwd Annual Div Yield|
|Exxon Mobil Corp||XOM||Energy||70%||9.49||10||2.40%|
|Apple Inc.||AAPL||Information Technology||50%||10.05||18||NA|
|Intl Business Machines Corp||IBM||Information Technology||65%||12.76||10||1.60%|
|Microsoft Corp||MSFT||Information Technology||45%||8.32||9||3.10%|
|Johnson & Johnson||JNJ||Health Care||53%||12.3||6||3.50%|
|Procter & Gamble||PG||Consumer Staples||65%||14.05||8||3.40%|
|General Electric Co||GE||Industrials||50%||10.13||12||3.80%|
|Pfizer Inc||PFE||Health Care||51%||8.67||3||4.10%|
Together, they make up 31% of the S&P 100 in terms of current market cap. Their average forward P/E is 10.5 times. Each company has a solid value proposition, strong free cash flow and above all, has a geographically well diversified revenue stream. The compelling argument is their foreign sales to total sales ratio ranges from 45% to 70%, and at an overall average of 54% is a full 8 to 9 percentage points above the 2010 foreign sales average for S&P 500 companies as a whole. Meaning, these are fundamentally strong companies, with lower than index forward P/E values, globally diversified sales revenues (across emerging Asia, Europe, Africa and the Americas), strong international brands, active in emerging markets, robust operating cash flows and positioned to weather regional macro headwind. What’s more, exposures to these stocks give you holdings diversified across IT, energy, industrials, healthcare, consumer staples and telecom. So, risk diversification along with a value investment strategy! And access to a fairly stable forward dividend yield of 3.5%.
Take a pause before you make the buy decision. We started off saying there is enough gloom on the global macro front. However, if you are willing to go long on cash and equity, time your entry and systematically invest-- chances are there will be enough ‘Apocalypse now’ scenarios playing out over the next several months, if not weeks, when markets display a reversal of the euphoria displayed this week on the back of the dollar swap rate cut. The market is latching on to any good news it can get, but is also likely to react asymmetrically on the downside. The moral of the story -- there’s probably enough value in solid balance sheet, large cap, globally diversified U.S. stocks to make decent risk adjusted returns in the medium term.