Did the financial crisis, and the subsequent economic recession, make us forget the underlying changes in the nature of corporate America’s earnings?
We started answering this question in our screencast earlier today as we discussed the growing gap between how professional investors and individual investors view the market. This Bloomberg article notes that while institutional investors continue to embrace equities, individuals are increasingly wary of the stock market. This is due to the fact that they have two very different perspectives on things.
Institutional investors are likely reacting to the results of earnings like those from FedEx that are reflecting the results from a growing, albeit slower than normal, global economy. Whereas individual investors are focusing on the steady stream of downbeat news coming from the domestic economy. It is indeed confusing to see this growing disparity between the real economy and the corporate economy.
Zachary Karabell at Time this week notes how the changing nature of corporate America and the global economy have made the link between the stock market and the national economy more tenuous. He writes:
Stocks are no longer mirrors of national economies; they are not — as is so commonly said — magical forecasting mechanisms. They are small slices of ownership in specific companies, and today, those companies have less connection to any one national economy than ever before.
This trend is likely to continue as the growing middle class in these emerging economies starts outpacing that of the developed world. In short this beyondbrics post notes:
Spending power is moving south and east, and it’s doing so at blistering pace.
This shift in spending power provides opportunities for growth that American companies simply do not see here domestically or in the rest of the developed world, like Europe. The above post mentions some companies poised to profit from these opportunities. It makes perfect sense to pursue them.
The long-term question for American companies is whether position in these large, rapidly going countries is both sustainable and profitable. If the answer to both of those questions is yes, then investors should feel comfortable putting a reasonable multiple on those earnings.
For investors the question of how to invest based on this knowledge is more problematic. The past few years have seen unprecedented levels of correlation between national stock markets, sectors and individual stocks. It seems that macro picture has outweighed whatever benefits one might have seen at the corporate level. John Authers at FT notes how:
The world trades in unison. Many bright people spend many long hours pondering which stocks, sectors or countries to buy but, of late, it scarcely seems to matter.
Some might take this observation to its logical conclusion that an all-domestic based portfolio is the optimal solution. We have written a great deal about this topic including this:
Therefore those who argue that an all-domestic portfolio avoids the messy problem of international diversification miss the big picture. Over some shorter time horizon this decision might very well turn out be a correct one. Nor is international diversification some sort of panacea. Investment risks abound both internationally (as well as domestically). However over the long term ignoring the increasingly dynamic nature of the global economy and the benefits from diversifying across it seems short-sighted at best.
The fact of the matter is we really don’t know what the true correlation is, or should be, between domestic equities and international equities. All we have is historical results which in the past decade have been punctuated by frequent crises. Eventually markets will return to something approaching a new normal. (How long they remain there is another question entirely.) At that point a new set of skills will be required of today’s macro-themed investors. Authers again:
Macro factors should dominate at present but not to this extent. The more investors behave on the assumption that the macro is all that matters, the more it tends to be true – and the greater the risks that stock prices get out of kilter. If the market ever calms down, the indiscriminate way investors now allocate their money should create a killing for those who pick their stocks carefully.
Whether we get back to some sort of golden age of stockpicking is less important than acknowledging that the world has changed around us. While those changes may be a mixed social and economic bag it behooves investors to take the lessons of the new global economy to heart. Anything less would mean living in denial.