Paul Ferraresi

The recent run up in emerging stock markets appears to continue in 2011. This is due, in part, as investors feel these economies will grow faster than their larger counterparts.

Another strong reason for the growth is that their stock buying population is growing faster. A great article in Barron’s on November 22nd, 2010, by Kopin Tan cited the following:

“Over the long run, certain emerging markets might be winners simply because their stock-buying population is swelling faster. A key metric to watch is a country’s proportion of people in their 40s to those in their 20s, which Ajay Kapur, Deutsche Bank’s Hong Kong-based strategist, dubs the Demi-Ashton ratio-after the 2005 pairing of the forty-something actress to her then-27-year-old sitcom star husband.

Think about it: In our 20s, we spend what little money we have on necessities like rent, tuition loans, bourbon and Eames chairs. Only when we grow older, wiser and wealthier-hopefully by the time we hit 40-do we allocate serious money to stocks and plan for retirement. No surprise then that as baby boomers came of age, the Demi-Ashton ratio in the U.S. shrank from 102% to 56% between 1960 and 1980-a nifty time for rock ‘n roll but drab decades for the stock market. By 2000, however, this ratio would rebound to 109% in a heady ascent that paralleled stocks’ boom.

While our Demi-Ashton ratio is projected to shrink slightly over the next two decades, the 40s-20s horde will surge to many emerging economies-to 84%, from 63%, in India; to 105%, from 73%, in Brazil; to 166%, from 78%, in Poland, and to 125%, from 99%, in China. Of course, things like valuations, financial crises, reforms and busts matter, too, and will create variations from this theme, Kapur notes “but there is no escaping the power of demographics.” He reckons the Demi-Ashton ratio will rise the most over the next five to 10 years in Indonesia, India and the Philippines within Asia; and in Brazil, Mexico, Poland and Turkey elsewhere.”

Just remember back to Hula Hoop, Transitor radios, Mustang, personal computers, cell phones, etc. You have an opportunity of a lifetime. The old adage was watch the baby boomers as they set buying trends. Don’t you wish you could have been the first investor in all the above trends? Well, you can… The emerging markets are going to do a replay of what we experienced.

Ah…discipline or regret!

Here is a great and timely quote from Jeremy Siegel. Jeremy, one of my mentors, is author of many books on the stock market and Professor of Finance at Wharton University. This quote is from an interview with Advisor Perspectives, on November 9th, 2010:

“One of the most remarkable developments over the past year is that the economy has been weaker than I and most people expected, to say the least.
I don’t think there’s a double-dip at all now, and I was not in that camp. But certainly I expected there to be a more robust recovery. Yet, despite that, earnings are higher than what I predicted and what almost all analysts predicted a year ago.

Think about this. The economy is much weaker, but earnings are higher. You can ask, ‘Well, how can that happen?’ It happened in two ways. First of all, it was because of strong global growth and the fact that so much of corporate profit, particularly for the S&P 500, comes from global sales. It was also because of remarkable cost-cutting and efficiency gains that were made by corporations.

What are the two things we know are the most important ingredients in determining stock price? It is earnings and interest rates. Earnings are higher than expected. Interest rates are lower than expected. So, when I look at the fair market value now of the market, I see it appreciably higher than our current levels, and I can easily see the market growing 10-20% over 2011.
And, by the way, I even see a nice gain through the end of 2010.

Margins are great. Certainly, we’ve done most of the cost cutting, and now we need the sales to increase. The leverage is huge. If firms can make profits with sales being as sluggish as they’ve been this year, think how much profit they’ll make if sales start going up. I’m one of those people who, whenever they announce the earnings and others say, ‘Oh my God, yeah, they topped their estimate on earnings, but they didn’t make their revenue,’ I say, ‘Hey listen, that’s not bad.’ I’d much rather they top on earnings and miss on revenue than fall short in earnings and make more revenue. If revenue is above what they expected and they can’t make their earnings, that’s not a good sign.

So, corporate America is levered up in such a way that when we do get that boost in spending, which I think will come in 2011, we will definitely get more profits.”

Although the new Republican Congress cannot make major changes with an Obama veto…I hear from business leaders they feel things will be more business friendly. If businesses are less restricted, this leads to more profits, which leads to more hiring and capital spending, which translates to more jobs and more consumers spending. All in all, in the depths of the financial crisis, the S&P 500 stood at 666. It has almost doubled since 3/09 to 1200. Jeremy is right on, so enjoy the ride.

New Cost Basis Reporting Laws

Individuals preparing their documents for tax reporting on stocks sold during the year always hit a wall. That wall is trying to find out when they bought the stock and how much they paid for those shares. The amount paid is known as their cost basis. On top of that, to determine their total cost basis, they must add in all dividends earned and capital gains to the cost basis (also known as tax basis). They add these items in as they have already paid tax when the dividends and gains were earned. The cost basis calculations have been a nightmare for some, but, it has been a benefit for others. You see, to date, the IRS had no way of knowing how much you paid to buy a stock or mutual fund. Only recently, brokers have reported only selling prices. So, an individual was left to tell the IRS their cost basis. Technically, one could create a gain or a loss without anyone knowing the truth. (I am not advocating anyone should do anything illegal). Hmm! What is the difference between tax avoidance and tax evasion ?…. about 20 years in the “big house”!

Well, a new federal law requires brokerage firms and mutual fund companies report their customer’s cost basis, gains/losses and holding period to the IRS when certain securities are sold.

There is a 3 year phase, in that this information must be sent to the IRS:

1) On January 1, 2011 – Equities only (excludes Regulated Investment Company stocks (RIC) and those Dividend Reinvestments Plans (DRIP).

2) On January 1, 2012 – Mutual funds, RIC stocks and equities enrolled in DRIP.

3) On January 1, 2013 – Fixed income, options, warranties, rights, derivatives and commodities.

So, read between the lines…You may want to make some purchases or changes to your portfolio to take advantage of an open window here – while it still lasts in 2010.

Discipline or regret!

The S&P 500 has averaged a return of about 13% per year (including dividends) since 1926. There have been periods of severe downdrafts as well as euphoric rises.

During the 1980s and 1990s the S&P 500 averaged a rate of return approaching 19% per year. So we had 20 years of returns well above the 13% average. Whether you call it “regression around the mean” or “what goes up….must come down,” prudence dictated that we would have many years of sub-13% performance. And so it was from 2000 to 2010.

This action in the stock market is not unusual; rather, it is a cyclic movement in the market as investors search out the most efficient position of their portfolios.

When all things seem to point “no place to go but straight up,” well you know a fall is coming in the market (like in 1999). When doom and gloom is the order of the day (like in 2010) and people declare….”I’m never going into the market ever again,” well, we are somewhere near the bottom.

There was a study of rolling 10-year monthly returns back to 1926, and, there are 776 of those monthly 10-year returns. But only 29 of the 776 were negative, or less than 4% of the total. You basically had a 1-in-25 chance of having negative returns. What is more interesting, though, is the subsequent 10-year returns after those negative returns. They averaged 9.8% with a high of nearly 15% and a low of 7.2%. (See Barron’s, September 6, 2010, page 38).

So, keep your powder dry and start your research into opportunities for future investment gains. It is not today or tomorrow that things will explode upward but in the near future. Don’t wait for the train to leave you at the station. After 40 years of advising I have heard the same stories at the top and bottom of each market. The words are always the same. The only difference is the faces.

In a typical off-year election, the opposition party to the presiding President gains seats. All the polls show a potential power swing for the Republicans in both houses of congress. This will provide gridlock….which means nothing gets done….and is music to the ears of stock market investors. This music is because no further damage can be done to businesses via additional regulation or taxes.

But beware….a powerful lame duck Democratic congress could steamroll insurmountable legislation through from November to January. All of the bills passed in the last two years will require multiple years to restore business and employment back to the previous higher levels, unless they are overturned.

Be prepared, as an investor, to change your thinking pattern of investing over the next few years because of the following:
• The large monetary and fiscal stimulus that was previously applied is running out of steam. (Most of the money was used to shore up union jobs and pensions. Very little was used for any new jobs.)
• Tightening of financial conditions.
• Leading indicators slowing down.
• Public and private deleveraging.
• Higher taxes, more regulation, trade tensions.
• European countries have slowed economically.
• Corporate profitability blossomed due to reduced expenses, but that is over. Consumer demand has fallen off, so corporate profits will drop.
• Deflationary pressure is coming on not just for prices but also for wages.
• Since fiscal and monetary stimuli have been used to the full extent, then another financial crisis will only lead to excessive money being printed.

Watch for the stock market to move sideways for a while with periodic deep drops. Gold will stay steady. Look at dividend paying stocks and short term bonds. By all means, begin moving into tax free, not tax deferred investments that provide guaranteed protection against loss with upside participation.

Watch the stock market during the week before the election. It will tell you which party will win.