Brightening Skies, but Risks Remain

Transcription

1 Brightening Skies, but Risks Remain Tom McManus Chief Investment Officer Wells Fargo Advisors July 2009

2 U.S. Equity Market: A Qualitative Report Card Macro-ECONOMY C (was D) Asset VALUATION B (was A) Market LIQUIDITY C (was D) Investor SENTIMENT* B (was A) * Revised range: A+ = Most Bullish. Normally interpreted in a contrary fashion. 1

3 Growth in U.S. Gross Domestic Product Adjusted for Inflation % e 2010e (Last data: Jun-09) Source: Blue Chip Consensus. 2

4 Most Major Economies: Contracting This Year 2010 Estimates Are Still Falling % e 2010e (Last data: Jun-09) Source: Blue Chip Consensus. 3

5 Resource Economies: 2009 Contraction % e 2010e (Last data: Jun-09) Source: Blue Chip Consensus. 4

6 Asian Tiger Economies Also Shrinking in 2009 % e 2010e (Last data: Jun-09) Source: Blue Chip Consensus. 5

7 381 Housing Prices: Now Below 40-Year Trend Losses Since 2006 Helping to Eliminate the Inventory Overhang $000s millions Inflation-adjusted Housing Price (Left) % Compound Annual Growth Rate Annual Housing Starts (Right) Note: Starts data through May at annualized rate. Source: Census Bureau, Case-Schiller, National Association of Realtors. 0 6

8 Expect Employment to Test the 1982 Lows 100 Civilian "employment" rate as % of Workforce '55 '59 '63 '67 '71 '75 '79 '83 '87 '91 '95 '99 '03 '07 Source: Bureau of Labor Statistics. 7

9 Smaller Firms Shedding Jobs Less Quickly Note Virtually All Payroll Growth Had Been in Smaller Firms 6.0 Payroll Increase (mill.) since Dec Payroll Increase (mill.) since Dec-00 Small Firms (fewer than 500 employees) Large Firms (500 or more employees) -3.0 (Last data: Jun-09) -3.0 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Source: ADP Employment Report. 8

10 Initial Unemployment Claims: Reached a Peak N.B. Historical claims adjusted for growth in the nation s workforce New Unemployment Claims (000, scaled to size of current workforce) 900 Index (percent) 4-wk Moving Average wk Moving Average "Hot-Cold Indicator" (Right Scale) COLD HOT '67 '70 '73 '76 '79 '82 '85 '88 '91 '94 '97 '00 '03 '06 '09 Note: Historical initial unemployment claims are scaled higher to reflect the significant increase in the size of the labor force over time. 4 and 40-week averages are shown to enhance clarity. The indicator at the bottom of the chart reflects the current level of initial claims as a percentage of the trailing 12-month high and low. If the current level of claims is at a 12-month high (low), the indicator will show 100 (0). Source: Department of Labor is year-to-date. 9

11 Cumulative Job Losses: Worst in 50 Years Job Growth in Recent Recoveries Has Been Noticeably Less Vibrant 102 Private Nonfarm Payrolls as % of Peak Month Jun-74 Sep-48 Current (began Dec-07) Note: Shows the percentage change in private nonfarm payrolls during each economic cycle since 1948, from the peak (indexed to 100) until the number of jobs eventually exceeded that of the peak month. Sources: Bureau of Labor Statistics, National Bureau of Economic Research. Months Since Peak in Private Nonfarm Payrolls 10

12 Consumer Confidence Has Improved Markedly After Plunging to Lowest Levels Ever Seen Conf. Board Consumer confidence US, 1985= '55 '58 '61 '64 '67 '70 '73 '76 '79 '82 '85 '88 '91 '94 '97 '00 '03 '06 '09 Source: The Conference Board. 11

13 Consumers Spending Rate is Likely to Fall Consumer Deleveraging to Be an Ongoing Trend in this Cycle Personal Spending as % of After Tax Income 5-year Moving Average '58 '62 '66 '70 '74 '78 '82 '86 '90 '94 '98 '02 '06 '10 Note: Spending is defined as personal consumption as a percent of after-tax income. Source: Bureau of Economic Analysis. 12

14 Retail Sales: Disappointing Gasoline Price Increases are Limiting the Effect of Stimulus 320 $ Billions / Month 242 May months shown for comparison (Not Seasonally Adjusted) Retail Sales: Ex-Autos & Gasoline (Seasonally Adjusted) Retail Sales: Ex-Autos & Gasoline (Not Seasonally Adjusted) Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 (Last data: May-09) Jan-08 Note: Log scale. Illustrates the significant seasonal adjustments required to report retail sales on a monthly sequential basis. Excluding auto sales and gasoline station sales, to better reflect the core retail purchasing decisions. Source: Census Bureau. 13

15 Investment Performance: a 10-Year Perspective Stocks and Corporate Bonds (High Grade and High Yield) FINRA Investment Grade Corp Bond Index S&P 500 Total Return Index Ryan Cash Index FINRA High Yield Corp Bond Index Rebased; Dec-98= 100 (Last data: Jun-09) Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Note: Past performance is not a guarantee of future results. An index is not managed and is unavailable for direct investment. Total return includes reinvested dividends. There is no assurance companies will continue to pay, or increase their dividends. Returns do not include commissions, fees or expenses which would have a negative impact on investment results. High-yield bonds, also known as junk bonds, are subject to greater risk of loss of principal and interest, including default risk, than higher-rated bonds. The S&P 500 Total Return index includes reinvested dividends. The FINRA/Bloomberg indexes of actively traded corporate bonds reflect 100% of the over-the-counter transaction activity in the index components. The Ryan Cash index is based on an 14 equal-weighted composite of auction-maturity US Treasury bills. Source: FINRA/Bloomberg, Ryan ALM, Standard & Poor s. 70

16 Historic Risk/Reward Tradeoff: Consider the Benefits of Diversification and Rebalancing 12% 10% 8% 6% Return / yr. "Free Lunch" 40 pct. Stocks / 60 pct. Bonds The shape of this curve depends on the correlation of stocks and bonds over the period. 100 pct. Stocks 4% 100 pct. Bonds 2% "Risk-Free" Rate 0% Risk / yr. 0% 5% 10% 15% 20% 25% Note: Based on annual total returns (dividends and income reinvested) from Indexes reflect annual rebalancing. * Diversification does not guarantee a profit or protect against loss. Source: Federal Reserve, Standard & Poor s. 15

17 Historic Performance: 50% Stock + 50% Bonds Rebalanced annually % T-Bonds (trend = 5.0% ann. rate) 50% S&P % T-Bonds (trend = 7.9% ann. rate) 100% S&P 500 (trend = 10.6% ann. rate) per cent of trend '25 '30 '35 '40 '45 '50 '55 '60 '65 '70 '75 '80 '85 '90 '95 '00 '05 '10 Note: Based on historical data of the S&P 500 and long-term Treasury bonds from Chart illustrates the indexed performance of two fixed portfolios (100% stock and 100% bonds) together with the indexed performance of a mix of 50% stock and 50% bonds, rebalanced annually. Each portfolio is shown relative to its own long-term trend. Past performance is not a guarantee of future results. Source: Federal Reserve, Morningstar, Standard & Poor s. 16

18 Long Term GDP Growth Drives U.S. Stock Prices Before Adjustment for Inflation , % of Mar-00 S&P 500 Composite Price Index +4.8% Ann'l. Growth Rate GDP x 100% Level (pts.) yr. Target 57% of 919; Jul-09 GDP x 50% % of Aug-29 31% of Jul estimates 2008 Note: GDP is Gross Domestic Product. Log scale, stock index shows capital appreciation only. Source: Blue Chip Consensus, Standard & Poor s, U.S. Commerce Dept., Wells Fargo Advisors The S&P 500 is an unmanaged index and is unavailable for direct investment. Past performance is not a guarantee of future results

19 Volatility s Effect On Our Long-Term Target Expect Volatility to Gravitate toward Its Long-Term Average 6.20 S&P 500 Total Return Index 6/2009= Upper limit of 95% confidence 20% annual volatility Upper limit of 68% confidence 20% annual volatility Projection: +10% Annual Total Return S&P 500 (including dividends) Lower limit (68% conf.) Dec-80 Dec-85 Dec-90 Dec-95 Dec-00 Dec-05 Dec-10 Dec-15 Dec-20 Note: Log scale, Total return includes reinvested dividends. There is no assurance companies will continue to pay, or increase their dividends. Returns do not include commissions, fees or expenses which would have a negative impact on investment results. An index is not managed and is unavailable for direct investment. Standard deviation measures the dispersion of a set of data from its mean. The more spread apart the data is, the higher the deviation. Source: Standard & Poor s, Wells Fargo Advisors 18

20 S&P 500 Sector Divergences: Extraordinary Growth & Inflation Beneficiaries at First Resisted the Downward Pull Indexed to 100 Consumer Discretionary & Financials: -51% Consumer Staples, Healthcare, & Utilities: -14% Materials, Energy, Industrials, Technology & Telecom: -25% *Note: 100 = 31-Dec-06. Past performance is not a guarantee of future results. An index is not managed and is unavailable for direct investment. Source: FactSet, Standard & Poor s 19

21 Economically Sensitive Stocks vs. Defensives A Bigger Rebound From Depressed Levels MS Consumer Index (CMR) MS Cyclical Index (CYC) (Reindexed to 100 on 1-Jul) 1-Jul 30-Sep Dec 31-Mar 30-Jun Note: Past performance is not a guarantee of future results. An index is not managed and is unavailable for direct investment. The MS Cyclical and Consumer indexes are broad based indexes, with stocks chosen from many industries. Each index comprises 30 large capitalization companies. The Cyclical index includes industries considered to be more economically-sensitive, while the Consumer index represents industries that are generally considered more immune to the swings of the economy. Source: American Stock Exchange. 20

22 Investment Performance: a 6-Month Perspective Large Capitalization Growth & Value Stocks, and Corporate Bonds FINRA Investment Grade Corporate Bond Index FINRA High Yield Corporate Bond Index S&P 500/Citigroup Growth Index S&P 500/Citigroup Value Index (Reindexed to 100 on 31-Dec) 31-Dec 60 2-Mar 30-Apr 30-Jun Note: Past performance is not a guarantee of future results. An index is not managed and is unavailable for direct investment. High-yield bonds, also known as junk bonds, are subject to greater risk of loss of principal and interest, including default risk, than higher-rated bonds. The FINRA/Bloomberg indexes of actively traded corporate bonds reflect 100% of the over-the-counter transaction activity in the index components. The S&P 500/Citigroup Growth and Value indexes represent perfectly complementary portions of the S&P 500 index, where there are 7 fundamental value-oriented factors determining the allocation of the shares of each company to either the Growth and/or Value index. Source: Standard & Poor s, Bloomberg. 21

23 Growth Stocks In the Lead So Far in 2009 We See Growth as a Better Long Term Risk/Reward Opportunity S&P 500/Citigroup Growth index relative to S&P 500 S&P 500/Citigroup Value index relative to S&P (Rebased to 100 on 1-Jul-08) 1-Jul 30-Sep 30-Dec 31-Mar 30-Jun Note: Past performance is not a guarantee of future results. An index is not managed and is unavailable for direct investment. The S&P 500/Citigroup Growth and Value indexes represent perfectly complementary portions of the S&P 500 index, where there are 7 fundamental valueoriented factors determining the allocation of the shares of each company to either the Growth and/or Value index. The underlying index is set to 100 at the start of the period to show the relative performance of growth stocks and value stocks in the S&P 500. Source: Standard & Poor s. 22

24 Surge Since Lows Favored the Average Stock As Compared to the Popular Averages S&P 500 Cap-Weighted Index relative to S&P 500 Equal-Weighted Index Large-Capitalization Companies Dominant Rebased; Dec-83= 100 Small- Capitalization Companies Dominant (Last data: Jun-09) Jan-78 Jan-82 Jan-86 Jan-90 Jan-94 Jan-98 Jan-02 Jan-06 Jan-10 Note: Past performance is not a guarantee of future results. An index is not managed and is unavailable for direct investment. The prices of small company stocks are generally more volatile than large company stocks. They often involve higher risks because smaller companies may lack the management expertise, financial resources, product diversification and competitive strengths to endure adverse economic conditions. Source: FactSet, Standard & Poor s

25 10 Credit Spreads: Significant Improvement Low-Grade Corporate Bond Yields Have Fallen, Quality Yields Rose Moody's Baa-Rated Long-Term, Yield, % Moody's Aaa-Rated Long-Term, Yield, % 10-yr. US T-Note Yield % '00 '01 '02 '03 '04 '05 '06 '07 '08 Source: Federal Reserve, FactSet. 24

26 High Yield Default Rate: May Rise to 12%+ Recessions More Difficult for Firms With Weaker Balance Sheets ,089 $Billions 0.0% Defaults Outstanding ($Billions) Defaulted % Estimated Default % 4.0% 8.0% % '71 '76 '81 '86 '91 '96 '01 '06 '11 High-yield bonds, also known as junk bonds, are subject to greater risk of loss of principal and interest, including default risk, than higherrated bonds. Left scale is a log scale, Outstanding value is based on par value of debt. Right scale is a reverse scale. Source: E. Altman, NYU Stern School of Business, Moody s. est. 16.0% 25

27 S&P 500 Compared to Consensus* Estimates For Next 12-months; Weighted P/E Multiple Now ~ 14x 1, S&P S&P 500 P/E Note: *Based on individual estimates for component companies. Past performance is not a guarantee of future results. An index is not managed and is unavailable for direct investment. Source: Standard & Poor s (log scale), Thomson Financial. 26

28 Value Line Index*: Near Bottom of the Channel Valuations Still Attractive Now at 15x Current Earnings 2, Value Line Index (Arithmetic) 22 1, % CAGR Value Line P/E Note: *The Value Line arithmetic stock index is a broad based index comprising 1700 companies and is equal-weighted. It is shown on log scale. P/E is based on centered estimates. Past performance is not a guarantee of future results. An index is not managed and is unavailable for direct investment. Source: Value Line. 27

29 Equity Valuation: Inflation Outlook is Critical Earnings and Dividend Yields Depend on Inflation Expectations 0 3 "The Disinflation Trend" Median Dividend Yield % Expected Inflation Rate 6 Median Earnings Yield % Risk Premium 5.0% 4.5% 4.0% 3.5% 3.0% 2.5% 3.5% Anticipated CPI Inflation Rate 3.0% 2.5% 2.0% 1.5% % Note: Dividends can be increased, decreased or totally eliminated at any point without notice. Source: Value Line. 28

30 25 20 Inflation, Deflation and Recessions Over the Past 150 Years in the United States CPI Annual - United States Source: Bureau of Labor Statistics, National Bureau of Economic Research. 29

31 PCE Price Indexes Show Low Inflation But Price Index Price Index Price Index Note the DEFLATION in Durable Goods (Autos, PCs, Furniture etc.) Services: 62% of Personal Expenditures; Price Index; [2000=100] 60-yr. trend: 4.7% CAGR 15-yr. trend: 2.9% CAGR Nondurable goods: 29% of Personal Expenditures; Price Index; [2000=100] 60-yr. trend: 3.6% CAGR 15-yr. trend: 2.3% CAGR Durable goods: 10% of Personal Expenditures; Price Index; [2000=100] 60-yr. trend: 2.0% CAGR 15-yr. trend: -2.0% CAGR Note: PCE is Personal Consumption Expenditures. Source: Bureau of Economic Analysis. 30

32 PCE Inflation: 80% of the Drop Since 1994 Has Been Moderating Prices For Stuff, i.e. Goods 4 Inflation Rate (% per year) 3.7% Services Nondurable goods 2 Durable goods 2.1% The inflation rate for durable goods shifted noticeably in 1994, swinging from +2.3% ( ) to -1.6% (1995 to 2009). This change alone has been responsible for 0.5% -- almost one-third -- of the drop in the annual inflation rate since then. Note: PCE is Personal Consumption Expenditures. Source: Bureau of Economic Analysis to to

33 Crude Oil*: Back to the Middle of the Range Suggest Investors Boost Commodity Exposure Back Up to Normal Inflation-Adjusted Crude Oil Price ($/Bbl.) S&P 500 including dividends (scale not shown) Dec-70 Dec-75 Dec-80 Dec-85 Dec-90 Dec-95 Dec-00 Dec-05 Dec-10 Note: Past performance is not an indication of future results. Dividends can be increased, decreased or totally eliminated at any point without notice. An index is not managed and is unavailable for direct investment. Buying commodities allows for a source of diversification for those sophisticated persons who wish to add commodities to their portfolios and who are prepared to assume the risks inherent in the commodities market. Any purchase represents a transaction in a non-income-producing commodity and is highly speculative. Therefore, commodities should 32 not represent a significant portion of an individual s portfolio. Log scale. *Energy prices are inflation-adjusted, S&P index is nominal. Source: Bloomberg, Energy Information Agency, Bureau of Labor Statistics.

34 Stocks and the Dollar: Long Term Trends Desperate Times Call For Desperate Strategies Dollar Still a Victim S&P Total Return Index S&P 500 Total Return Index; Right scale US Dollar index; Left scale 11/07= USD Index 12/66 = Dec-66 Dec-71 Dec-76 Dec-81 Dec-86 Dec-91 Dec-96 Dec-01 Dec-06 Note: Log scales. Past performance is not a guarantee of future results. An index is not managed and is unavailable for direct investment. Grey bars indicate recessionary periods. Currency weights determined by amount of foreign holdings of U.S. stocks. Source: Federal Reserve, S&P. 33

35 Home Prices: Valuations Becoming Reasonable Affordability Indexes Reflect Sales, Income, & Financing Trends 0 NATIONAL 10 San Jose-Sunnyvale-Santa Clara, CA 20 Las Vegas-Paradise, NV Less Affordable San Diego-Carlsbad-San Marcos, CA Lakeland-Winter Haven, FL More Affordable 100 Mar-91 Mar-93 Mar-95 Mar-97 Mar-99 Mar-01 Mar-03 Mar-05 Note: Affordability is shown on a reverse scale; the peak in housing prices is shown at the top of the chart. Source: National Association of Home Builders. Mar-07 Mar-09 34

36 Fed at Rock Bottom Decline in LIBOR Overnight Indexed Swap is a Positive 3 mo. LIBOR 1) 2) Fed Funds Overnight Rate 3 mo. Overnight Indexed Swap 3 mo. T-Bills mo. LIBOR Overnight Indexed Swap Note: LIBOR (London Interbank Offered Rate) is a daily reference rate based on interest rates at which banks borrow unsecured funds in the wholesale market. Three-month USD LIBOR is the quoted interest rate at which banks can borrow US dollars for a 3-month period. The Overnight Indexed Swap represents the market s expectation as to the average fed funds over the upcoming 3 months. Past performance is not a guarantee of future results. An index is not managed and is unavailable for direct investment. Source: British Bankers Assn., Federal Reserve, Bloomberg. 35

37 Volatility Index: Good Record Identifying Lows Portfolio Insurance Demand Surges as Investors Lose Composure Dow Jones Industrials (Deviation from Trend) (Left) CBOE Volatility Index (VXO), Percent (Right) -3 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 Note: Volatility index is shown on a reverse scale. Solid line represents the deviation from the 5-year trend of the Dow Jones Industrial Average. Source: Chicago Board Options Exchange, Dow Jones, FactSet. The CBOE OEX Volatility Index (Chicago Board Options Exchange) reflects a market estimate of future volatility, based on the weighted average of the implied volatilities of 8 OEX calls & puts. The Dow Jones Industrial Average is based on 30 major companies weighted by price

38 In Prior Cycles, Equities Have Tended to Lead Employment Has Tended to Lag Dow Jones Industrials: Deviation from Trend (Left) Civilian Employment rate (Right) -2.8 '55 '58 '61 '64 '67 '70 '73 '76 '79 '82 '85 '88 '91 '94 '97 '00 '03 '06 ' Note: Past performance is not a guarantee of future results. An index is not managed and is unavailable for direct investment. Reverse scale (top). Shaded areas represent US recessions; hatched area presumes recession continues through Sep 09. Source: Bureau of Labor Statistics, FactSet. 37

39 Wrong Way on Corporate Taxes 395 $B 308 Trend: +5.8% Compound Annual Growth Rate 240 US Corporation Tax Revenue % 2 Corporate Tax Revenue as a % of GDP Source: Office of Management & Budget, U.S. Treasury estimates

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