Outlook for Equities
It has been a rough run for equity investors over the past decade. Between 2000 and 2010, investors endured the bursting of two major asset bubbles (tech and housing), two momentous recessions and two bear markets for equities. At the same time, the economy lost some significant companies like Enron, Arthur Andersen and WorldCom, not to mention the gigantic financial firms that failed during the recent credit crisis.
However, if fund flows are any indication, investors are starting to re-enter the race. Morningstar data shows that after sprinting into bonds and out of equities for the better part of 2010, investor assets may be taking a turn—and with good reason. Chris Leavy, BlackRock's Chief Investment Officer of US Fundamental Equities, sees great potential in US stocks. "Equity markets have certainly risen strongly since their March 2009 bottom," says Mr. Leavy, "but it would be a mistake to think that investors have missed the race. By our analysis, stocks have further to go, and we think they represent a strong investment opportunity for years to come."
Given the spectacular flight out of equities and into fixed income during the credit crisis two years ago, Mr. Leavy also believes that most investors are under-allocated to equities and expects that the increasing demand that we're just starting to see now should support equity valuations going forward.
Bob Doll, Chief Equity Strategist for Fundamental Equities and lead portfolio manager of the BlackRock Large Cap Series (Core, Growth, Value), echoes that view: "From our vantage point, we are expecting the next 10 years to produce a significantly better environment, and are forecasting annualized US stock market returns of close to 8% for the coming decade," says Mr. Doll, adding that a combination of supportive fiscal and monetary policy, decent economic growth, low inflation, strong corporate earnings and decent valuations should be a recipe for stock price appreciation in 2011.
Room to Run
Investor Shift to Equities Still in Early Legs
Source: Morningstar Inc., Morningstar Direct Fund Flows.
The Price Is Right
As investors well know, the calamitous bubble-bursting events of the last decade caused a significant bear market for equities. Perhaps less understood is the fact that while prices were falling sharply, corporate earnings performed relatively better. This caused a compression in the price-to-earnings (P/E) multiple investors were paying for US stocks, meaning prices are cheaper now than they were 10 years ago. According to Mr. Leavy, the P/E multiple that investors paid for US equities declined from a high of 24x in 2001 to forecasts of 13.3x for 2011.
"The case for equities going forward is about the value, and the growth in that value, that companies will return to shareholders in the form of earnings growth, dividends and share buybacks, acquisitions and other methods of value creation," says Mr. Leavy, who adds that a rise in P/E ratios from still-low levels would only bolster the base case for equities.
Given the notable compression in P/E ratios already, and two years of strong stock market gains, some investors wonder if they've missed the opportunity in stocks. While the "once-in-a-generation kind of buying opportunity" may have passed, Mr. Leavy believes the outlook for equities is still very compelling based on companies' strong fundamentals and large cash balances.
Cash Is King
Mr. Leavy's optimism is focused on the fundamental basis of equity investing — the ability of a company to generate cash. He explains:
"You've probably heard the saying 'cash is king.' Well, there's truth to that, particularly as it relates to putting a value on equities. Cash allows companies to transmit value to shareholders through dividends or share buybacks, or to make acquisitions that increase the earnings power of the company, and extend additional profits to the shareholder. This cash becomes the fuel for corporate growth and profitability in the future."
Right now, after the Great Recession and credit crisis that caused companies to hoard cash in fear, companies have unprecedented amounts of cash on their balance sheets. (See chart below.) Both Mr. Leavy and Mr. Doll expect these companies will return this cash to shareholders by conducting more share-buyback programs and increasing dividend payout ratios over the next several years.
Strategies for Investors
For those who are looking to add to their equity exposures, our senior equity investors offer the following advice:
With corporate cash at historic highs and the expectation that companies will put that cash to work for the benefit of shareholders, Mr. Leavy recommends a focus on global dividend-paying companies. In addition to providing income that rivals that of Treasuries currently, dividend-paying companies tend to be higher quality and more stable than other companies. "I would say investors should seek global multinational companies that pay dividends in order to take advantage of twin drivers: volume growth advantages of global companies with emerging markets exposure, and compelling corporate cash dynamics."
Mr. Doll adds, "We think investors need to hold a mix of both high-quality and cyclical stocks in their portfolios. We're seeing opportunities across capitalizations, investment styles and geographies."
In the current market, Mr. Leavy believes it is important to take advantage of the long-term returns of equities as an asset class rather than try to tap the strength of one specific sector. "Investors should think about increasing their allocations to equities in general, as there are risks to not being invested in an improving environment."
Despite heightened volatility in world markets recently, these BlackRock investment pros believe it is important to maintain a long-term view, be selective when choosing investments and look for buying opportunities that might arise out of short-term upheaval. Working with a professional investment manager also can be helpful at times like these. Mr. Leavy concludes, "Staying flexible and not following the consensus are important parts of a successful investment strategy, so investing in actively managed portfolios that can tap developing and diverse opportunities can be a real advantage for investors."
Companies in Strong Financial Shape
Corporate Cash Balances at Historic Highs
Source: Citi Investment Research. Represents cash as a percent of S&P 500 market value (ex financials).
"US equities remain one of the most underinvested asset classes today. People have underinvested in the US equity market for years — and overinvested in fixed income. This has left equities very cheap compared to credit spreads."
— Larry Fink, Chairman and Chief
Executive Officer of BlackRock
Archived articles are current as of the original date of publication.