CPI Y/Y % Charts for the beach Richard Bernstein August 9, 2013 Our basic positions are now famous (or infamous). We continue to favor US assets and to shield our portfolios from the on-going and broad problems in the emerging markets. In the spirit of August, we forego significant text this month to present a series of charts that outline a few of the opportunities and risks we see in the global markets. Emerging market problems are secular, not short-term. Some emerging market enthusiasts have argued that the problems in many of the emerging markets are only short-term. Unfortunately, the data increasingly point to secular issues. In addition, the problems are not only in the BRIC countries (Brazil, Russia, India, and China). The economic and profit problems have spread to the wider group of emerging market countries. Chart 1 looks at the relationship between inflation and monetary growth around the world. Note that the highest rates of inflation and monetary growth are in the emerging markets. Meanwhile, US monetary growth is almost identical to its longterm average. Chart 1: 10% 8% 6% Global Growth in Money Supply *vs. Inflation Rate Country Key: Purple= Emerging mkts Blue= Developed mkts Orange= BRIC mkts (latest available as of 7/30/2013) Brazil South Africa India Turkey Russia Indonesia Egypt 4% Mexico Hong Kong Philippines 2% 0% Portugal UK Australia Austria Hungary Czech Rep. Germany Norway Spain Belgium US Finland South Korea Italy Canada N.Z Denmark France Ireland Japan Taiwan Poland Sweden Greece China Malaysia Thailand Singapore Switzerland Colombia -2% -5% 0% 5% 10% 15% 20% Money Supply Y/Y % Change Source:, Bloomberg *Money Supply defined as M2 (or M3, if M2 not available, or IMF Currency Issued by Monetary Authority in National Currency, for EMU countries).
The US may be a better growth story than the emerging markets Chart 2 shows a comparison of global twelve-month forecast EPS growth rates. Note that the projected growth for US small cap companies (i.e., domestically focused companies) is about double that for emerging market companies. Could the US actually be a better growth story than EM is? The data certainly suggest that is the case. Chart 2: 30% US vs. EM: Next 12M EPS Growth Rates (as of 7/31/13) 20% 10% 0% US Small Cap World US Mid Cap EM US Large Cap Source:, Bloomberg. For Index descriptors, see "Index Descriptions" at end of document. Is Japan for real? We continue to be bullish on Japan as well. As we ve noted before, Japan s demographics and relatively poor productivity leave them few options other than depreciating their currency. Historically, there has been a fairly good relationship between a depreciating Yen and an appreciating Japanese stock market. More recently, the government has been suggesting policies that could add to their bull market. Most critical to us has been their idea to restart their nuclear plants. Japan is a notorious importer of energy, and depreciating the Yen could cause energy inflation which could negate their attempts to rejuvenate their economy. Producing energy domestically, i.e., restarting nuclear plants, will help to alleviate the potential risk of energy inflation choking the recovery of the Japanese economy. Chart 3 shows the performance of the Nikkei Index from mid-1980 on. 2
Chart 3: Source: Bloomberg The American Industrial Renaissance is real. Although skeptics abound, small and mid-cap manufacturing and industrial companies continue to gain market share. We feel this is one of the world s best growth stories. Are the benefits of the theme widespread and visible? Of course not. That would likely be the warning sign that the theme is in its late stages. Despite the skeptics, small capitalization industrial stocks continue to outperform the global equity markets. (See chart 4). Chart 4: Source: Bloomberg 3
Why is the stock market up so much? Politicians crave the spotlight, but it s a shame that investors watch the show. Washington s theatrics have diverted investors attention away from the factors that actually influence stock market performance. Although politicians and economists focus on the absolutes of good or bad, the stock market tends to focus on better or worse. That is a subtle, but very important difference. With that in mind, one must accept that virtually every economic statistic in the United States has improved over the past several years. Certainly, the economy is not good in an absolute sense, but it has improved. Whether the economy is strong is an interesting socio-economic issue, but it is not an investment issue. In addition, we doubt there is any other country in the world about which one could make a similar statement regarding widespread improvement over the past several years. This is the simple reason the US stock market is up so much. The US has experienced perhaps the only broad based recovery in the world. Most investors can t believe that the US might actually be a growth story. Their disbelief is the basis for our on-going bullish positioning within our portfolios. 4
INDEX DESCRIPTIONS: The following descriptions, while believed to be accurate, are in some cases abbreviated versions of more detailed or comprehensive definitions available from the sponsors or originators of the respective indices. Anyone interested in such further details is free to consult each such sponsor s or originator s website. The past performance of an index is not a guarantee of future results. Each index reflects an unmanaged universe of securities without any deduction for advisory fees or other expenses that would reduce actual returns, as well as the reinvestment of all income and dividends. An actual investment in the securities included in the index would require an investor to incur transaction costs, which would lower the performance results. Indices are not actively managed and investors cannot invest directly in the indices. US Large Cap: Standard & Poor s (S&P) 500 Index. The S&P 500 Index is an unmanaged, capitalization-weighted index designed to measure the performance of the broad US economy through changes in the aggregate market value of 500 stocks representing all major industries. US Mid Cap : Standard and Poor's MidCap 400 Index: The S&P MidCap 400 Index is an unmanaged, capitalization-weighted index designed to measure the performance of the mid-sized companies of the U.S. stock market. US Small Cap: Standard and Poor's SmallCap 600 Index: The S&P Smallcap 600 Index is an unmanaged, capitalization-weighted index designed to measure the performance of the small cap segment of the U.S. stock market. World: MSCI All Country World Index (ACWI ). The MSCI ACWI is a free-float-adjusted, marketcapitalization-weighted index designed to measure the equity-market performance of global developed and emerging markets. EM: MSCI Emerging Markets (EM) Index. The MSCI EM Index is a free-float-adjusted, market-capitalizationweighted index designed to measure the equity-market performance of emerging markets. Japan: Nikkei: The Nikkei 225 (NKY) Index: The Nikkei-225 Stock Average is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. The Nikkei Stock Average was first published on May 16, 1949. Copyright 2013. All rights reserved. Nothing contained herein constitutes tax, legal, insurance or investment advice, or the recommendation of or an offer to sell, or the solicitation of an offer to buy or invest in, any investment product, vehicle, service or instrument. Such an offer or solicitation may only be made by delivery to a prospective investor of formal offering materials, including subscription or account documents or forms, which include detailed discussions of the terms of the respective product, vehicle, service or instrument, including the principal risk factors that might impact such a purchase or investment, and which should be reviewed carefully by any such investor before making the decision to invest. Specifically, and without limiting the generality of the foregoing, before acquiring the shares of any mutual fund, it is your responsibility to read the fund s prospectus. Links to appearances and articles by, whether in the press, on television or otherwise, are provided for informational purposes only and in no way should be considered a recommendation of any particular investment product, vehicle, service or instrument or the rendering of investment advice, which must always be evaluated by a prospective investor in consultation with his or her own financial adviser and in light of his or her own circumstances, including the investor's investment horizon, appetite for risk, and ability to withstand a potential loss of some or all of an investment's value. Investing is an inherently risky activity, and investors must always be prepared to potentially lose some or all of an investment's value. Past performance is, of course, no guarantee of future results. 5