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Hank Herrmann
CEO,
Chairman of the
Investment Policy Committee
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Ivy Funds Market Perspective – January 2012
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Looking back at 2011, the keywords of the year for the financial markets seemed to be volatility and uncertainty. The S&P 500 Index, as an example, saw 11 days when it increased 2 percent or more, and 19 days when it decreased 2 percent or more over the course of the year through November, according to Bloomberg.
While some issues have changed or evolved as we enter 2012, there are issues that continue to hang over the financial markets, namely the European debt crisis and whether the region can sustain a fiscal union, and the political environment in the U.S. as we proceed through a presidential election year.
But amid the changing news and uncertainty, while many investors have sold on the lows or held cash at historically low rates, we’ve seen something behind the headlines. Economic fundamentals in the U.S. are steadily improving. Amid the uncertainty, we see a positive outlook for domestic equities.
Fundamental facts
While the macro issues around the world have simmered, we continue to see positive fundamental statistics in the U.S. that reinforce a more constructive outlook. There are a number of reasons to feel positive; and when you put the pieces together, we believe that the U.S. may be one of the more attractive places to invest in a challenging global environment. Let’s look at several key points:
- The dollar is in a period of improvement against foreign currencies, which means money is likely to flow from offshore into U.S. financial assets. With the challenges in the eurozone, global investors with significant exposure to European assets are likely to move their assets elsewhere. We believe the logical place to move, on a valuation and a quality basis, is the U.S.
- Thanks in large part to aggressive stimulus measures that have been in place since 2008, the U.S. economy is steadily improving. Unemployment is still too high, but the job market is looking better, as unemployment claims in mid-December came in at the lowest level since 2008. The unemployment rate has fallen nearly a point. Factory orders have been increasing for months and retail sales are rising more than expected, especially auto sales. It is apparent that the U.S. has avoided the double-dip recession that many feared just a few months ago. U.S. gross domestic product (GDP) growth is projected to come in around 3.5 to 4.0 percent for the fourth quarter of 2011, and while it may slow some in early 2012, it is still projected to rise approximately 2 percent for 2012, which is strong relative to the rest of the developed world.
- The U.S. federal deficit is now contracting, in part because war costs are going down, but also because tax receipts are rising, driven by better corporate earnings and more people working.
- Our trade deficit also is getting better. U.S. dependence on imported oil is diminishing, due to new technology that allows development of very substantial deposits of shale gas and oil here at home. These new resources may over time help to strengthen our trade balance and our geopolitical position.
Combine all of this with the fact that the valuations on U.S. equities look very reasonable right now, particularly if you factor in some improvement in corporate earnings in 2012, and you begin to see potentially better returns. According to Birinyi Associates, in 2011 U.S. companies authorized spending more than $453 billion to buy their own stock, putting 2011 on track for the third highest annual total behind 2006 and 2007. Given where the stock market is presently priced, it appears to us that we are at the lower end of a wide band for price-to-earnings (P/E) ratios. Companies in the U.S. have some of the strongest balance sheets in the world, and domestic equities look more attractive to us than elsewhere at this point.
There’s always a caveat, or two
In fact, there are seemingly more than two at this point. The two that follow, however, are especially important at this juncture.
Election years are unpredictable by nature and the U.S. is in the midst of a particularly partisan and acrimonious one. Political uncertainty is likely to dampen the potential of the domestic equity market somewhat as we move toward November. We can’t overstate the importance of politics; it will get much attention in the coming months. Regardless of the outcome of the election, however, the U.S. will move toward more fiscal responsibility. Our hope is that the politicians can move toward consensus on this key issue without prodding from the financial markets.
In Europe, we are likely to see some material restructuring, although the form of that remains unclear, hence more uncertainty. As we’ve noted many times, financial markets don’t like uncertainty. Will the eurozone see fiscal union, with financial oversight under a common authority? Or could we see a membership restructuring? The political and financial issues in Europe are thorny but not intractable. They will take time to resolve, and will be an overhang for investors in the coming year.
As we look forward, we think the U.S. equity market provides strong potential in what continues to be an uncertain global financial and political environment.
The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered to represent the U.S. stock market. Investments cannot be made directly in an index.
Past performance is not a guarantee of future results. The opinions expressed in this article are those of Mr. Herrmann and are current through January 2012. Mr. Herrmann’s views are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. Waddell & Reed Financial, Inc. is the ultimate parent company of Waddell & Reed, Inc. and of Ivy Funds Distributor, Inc.
Investors should consider the investment objectives, risks, charges and expenses of a fund carefully before investing. For a prospectus, or if available, a summary prospectus, containing this and other information for the ivy Funds, call your financial advisor or visit www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.