Shaping a portfolio for 2012 (IV): the US

US:  stocks vs. economy

It’s increasingly important in looking at the current US stock market, as it typically has been with almost every other national bourse, to distinguish between the health of the domestic economy and the prospects for the stocks listed there.

How so?

According to the best information from Standard & Poors (not every member of the S&P 500 chooses to break out revenues geographically), only 50% of the revenue generated by the 500 come from the US.  About 25% are sourced from Europe and the rest from emerging markets.

In today’s US, as has been the case for the last generation elsewhere, one of the first questions an investor should ask is whether economic growth inside the country will be better or worse than growth abroad.

So let’s look at the US economy.

the economy

the Great Recession

The domestic housing bubble began to collapse of its own weight in mid-2007.  The economy reached its nadir in mid-2009 and has been recovering since.

recovery

Three bumps in the road:

–the boost from spending deferred by companies and individuals during the down turn was exhausted in mid-2010 and the economy slowed somewhat.

–the Fukushima nuclear disaster disrupted industrial supply chains in March 2011.  That’s basically over.

–worries about a financial implosion of the EU that could send negative ripples globally caused companies worldwide to shrink inventories, starting in the summer.  That downward adjustment appears to have just ended.

Looking into 2012,

the economic situation in the US seems comparatively good:

–the housing market may finally be bottoming, in all but the areas worst affected by speculation, after almost five years of decline

–much of the excessive debt taken on by consumers during the bubble has been worked off during three years of restrained consumption

–employment is improving at a slow, but gradually increasing, rate

–real growth in the US will likely be around +3% for this year, which would make the country the best performer among the major developed economies.

Yes, the US faces longer-term problems:  substantial government debt, continuing government budget deficits, increasing competition from China and other emerging countries, the decades-long failure of either major political party to develop a policy agenda relevant for contemporary America.  There’s also the near-term question of fallout from potential economic/financial problems in Europe.

Still, relative to both its own experience over the past several years and prospects for the reset of the developed world. the US is looking pretty good.

the stock market

From a simple top-down perspective, I think market strategy is clear:

–there’s a clear case for overweighting the US vs. Europe or Japan.

One might also argue for overweighting the US vs the emerging world as well, since domestic earnings will likely be expanding at an accelerating rate while emerging markets’ profits, although growing faster, will be doing so at a decelerating rate–but I’m less confident that this is the right thing to do.

–one should emphasize domestic-oriented firms vs. international companies, especially those with exposure to the Eurozone

–manufacturers of industrial equipment and consumer durables should do relatively well

–expect consumers to continue the process, already begun, of trading back up to the higher-end brands they abandoned during the recession

–given that growth stock beneficiaries of structural change have been the biggest winners until the past few months, it’s possible that traditional business cycle-sensitive value stocks will have their day in the sun.

Nothing’s ever that easy, though. 

The internet, as wielder of the sword of creative destruction, continues to wreak havoc among bricks-and-mortar retailers and the strip malls they inhabit.

The question of whether the current high unemployment rate is cyclical or structural (I’m in the structural camp) is also relevant.  If you think high unemployment is cyclical–and that continuing economic growth mostly means the long-term unemployed gradually get their jobs back–buy WMT or DG.  If you think it’s structural–and that growth mostly means the currently employed get raises–buy TIF or JWN.  (Note: for the past six months, DG has been the clear winner, with WMT in second place.  Is this a counter-trend rally or the start of a new trend?  If the former, is it already mostly played out?)

Luckily, there’s no need for any investor to have a strong opinion about everything–or to act on everything he has an opinion about.  Instead, the secret to success is to understand what the issues are, but to locate a small number of things that you have the highest degree of confidence in to invest in.

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