TPWC Market and Economic Update – February
Building the Optimal Portfolio
Greetings from The Personal Wealth Coach®!
In this letter I depart a little from my tradition and confined myself to a single story. I believe that it is very important that you read these four pages of my prose carefully, because what is presented here is at the core of what makes for success or failure in most investment portfolios.
Over the 12 months ending in January of this year, the S&P 500 Stock Index rose 22%. Its compound average annual return for the past couple of years has hit a whopping 40%! As a result from March 9th of 2009 through here in mid-February of 2011, the Index has risen 100%!
Most people’s first thought at this point seems to be that a 100% rise in less than two years must mark an overpriced market. The facts argue otherwise. First, we are not back to where the Index was in 2007, so for most people who invested four years ago, their portfolios still show a loss. Second, the Dow Jones Industrial Average and the S&P 500 Indexes are barely back to the levels they reached eleven years ago. The fact that the market has risen 22% is dwarfed by the fact that the average reported earnings of S&P 500 companies with about three3-quarters of them having reported, is up 30% from last year. The price to earnings ratio (P/E) of the S&P 500 is still substantially below its long term average. In short, the market is still well below its normal historical valuation.
The long term trend in the broad U.S. Stock Market is still well above where that market is valued today. Today’s market levels are actually about 44% below their long term averages. That does not mean the rise to “normal” historical valuations will be either swift or smooth. If history is any guide, the second half of the recovery will be considerably more bumpy than was the first.
Further reinforcing my view that we have a ways to go was Chairman Bernanke’s testimony that he expects the U.S. economy to grow at about 3.9% per year for the next several years. That kind of growth only comes from a very undervalued economic environment.
At the same time, core inflation is running at about as low a level as any of us have ever seen it at just about 1.5% for the year 2010. Despite rising prices on food and fuel, there is no evidence that we are likely to see any significant inflation in the near future. In order for inflation to get a toe-hold, wages have to increase. The reality is that wages are not only holding steady, but are in many areas falling. As long as there is a large number of unemployed people in the country, there will be little likelihood that employers will be raising wages. Municipal employers are actively cutting positions and wages at the same time.
In short we are in an improving economy that is currently running ahead of the market with little suggestion of anything that looks like inflation. The danger at this point is probably more from attempting to get a higher return than is safe than from economic problems. At the same time though there are situations in Europe and Asia that could damage the global recovery. Still, when I add everything up, the positives look a lot bigger than the negatives.
As always, your comments, questions, and opinions are welcome!
Jeff McClure
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