How long can this last? The U.S. stock market is out performing the world

03/19/2010 8:30 am EST


Jim Jubak

Founder and Editor,

I can think of a dozen reasons why in the long term U.S. stocks will underperform stocks in China, Brazil, India, Canada may be even Norway, South Africa, Germany, and Turkey. Huge government debt, highly leveraged consumers, under-investment in infrastructure, a lagging educational system, rising interest rates, a small and (in industries such as autos) uncompetitive manufacturing sector, out of control healthcare costs… Do I need to go on?

But in the next three to six months, I can’t think of a better stock market in the world for my money. China? Beijing is raising interest rates and shrinking the money supply. Brazil? Rate increases and all the uncertainty that comes with a close presidential election. India climbing inflation and interest rates.

In contrast, the United States looks like it’s in for stable interest rates. Inflation just high enough to take worries about deflation off the table. Easy year to year corporate earnings comparisons with the first half of 2009.

Hey, I still think the excrement is likely to hit the whirling blades in the last quarter of 2010 or early in 2011, but in the short-run the U.S. stock market looks, comparatively, like the best bet in the world for equities. I’m not saying the U.S. market and economy are perfect or wonderful—just that for this period they look better than the other guys.

Not so fabulous that I want to go out and bet the farm on U.S. stocks, but good enough so that I might want to add a dash of U.S. stock to my portfolio for the next quarter or two. Not so attractive for the long run that I want to tear up my long-term plan to over-weight developing market equities. Over five to ten years I think stocks from China and Brazil and the rest of the developing world will leave U.S. stocks—and even more so stocks from other developed economies--wallowing in their dust. But attractive enough in the short-run that putting some cash to work in U.S. stocks makes sense.

After my sell of GulfMark (GLF) on March 10, Jubak’s Picks is up to 14% in cash. I’m going to put some of that to work with a buy at the end of this column. And I’ll give you two more potential buys if you’ve got more cash on the sidelines than I do in your portfolio.

One of the lessons that the bear markets of 2000 and 2007 should have taught us is that investors need to think both long and short term. It’s not enough to put your money behind a great long term stock and then forget about it, lulled into complacency by a belief that in the long run your investments will do fine. In the short-run, we’ve learned even the best long run stocks can take beatings so horrible that most investors can’t hold on for the turnaround.

Google (GOOG), for example, is in my opinion a great long-term investment. But that doesn’t mean you could just buy and forget about it in the last five years or so. Look at this volatility:

On September 30, 2005 Google sold for $316 a share.

By October 1, 2007 it was at $583 and you were up 84%.

By November 24, 2008, it was down to $257 and you were down 56% from October 2007 and even down 19% from September 2005.

On March 16, 2009, the stock was back to $565. And an investor was either up 120% from November 2008, or down 3% from October 2007 or up 79% from September 2005.

I’m not saying that you had to trade Google during these market ups and downs in the hope of catching the tops and bottoms. But you sure could have used tools as time-honored as dollar-cost averaging (to buy more when shares are cheap and less when they’re expensive), or growth at a reasonable price (to sell some of your position when the stock is trading at a high price-to-earnings to growth rate (PEG) ratio and buying when Google’s growth was relatively cheaper) or good old portfolio rebalancing (to trim big positions) or by-the-book portfolio diversification (to keep the asset classes you own in balance) or even some macro-economic timing (to sell when the economy for advertising, Google’s main product after all, soured and to buy on prospects for recovery.)

Anything that might have leveled out some of the volatility and increased your sense that you had some control over your portfolio. Feeling like you can’t do anything that matters leads to panic and then, frequently, to selling in despair at the bottom. If all that your strategy does is help you hang on in the short-term through the volatility so that you actually reap those long term rewards, then that strategy is working for you.

Same with a market like this one that’s constantly setting out the punch bowl and then taking it away. The short-term rallies and reversals, the head-fakes and the bear traps are enough to drive you either out of the market totally because it’s just too frustrating or to gradually entice you into taking on more risk than you should out of frustration. I want you to stay in the market for the long run without taking on more risk than you should, and I want you to pay attention to what’s expensive and what’s not and to the balance in your portfolio even when volatility is driving you crazy.

Oddly enough I think focusing some attention and a little bit of money on the short-term is exactly how to keep from blowing up your long term strategy out of frustration. (I suggested this same kind of short-term/long-term thinking for income investors in my post )

How frustrating is this stock market right now?

Think about 2009 when everybody was saying that China’s stock were the great long-term growth story of our time. (I agree—mostly. I do prefer some other developing markets to China but China is, in my opinion, an amazing growth story for the next decade or two. For what countries I prefer to China see my )

And this year? Blah! (A highly technical financial term. Sorry to use jargon but sometimes it’s necessary.)

The iShares FTSE/Xinhua China 25 ETF (FXI), which tracks 25 of China’s biggest companies, was down 5% for 2010 as of March 16. The Shanghai Composite Index was down 9.2% for 2010—and that’s after rallying from the February low.

And the much reviled—and over the long-term perhaps justly scorned—U.S. stock market? The Standard & Poor’s 500 Stock Index was up 2.3% for the year as of March 16. (And up 10% from the February 8 low.)

That’s not a huge gain but remember we’re talking about what’s likely to be a really tough year for stocks—if the U.S. stock indexes deliver 10%, I’d be ecstatic—and we’re talking about not just absolute but comparative performance. That piddling 2.3% gain on the S&P 500 is a huge 11.5 percentage points above the loss delivered by the Shanghai market this year.

I think there are good reasons to expect that this out performance will continue for somewhere between three and six months.

Do the comparisons and you’ll see why.

  • On March 16 the Federal Reserve’s Open Market Committee renewed its promise to keep interest rates at the current 0% to 0.25% target for an “extended period.” China could raise interest rates as early as April. Brazil will raise rates this year. So will India.

  • U.S. inflation isn’t headed anywhere in the short-run. U.S. inflation rose at an annual rate of 2.6% in January (We get February numbers on March 18). More important than the absolute number is the direction. U.S. inflation was down from 2.7% in December. In China, on the other hand, inflation spiked to 2.7% in February. That’s after dropping to 1.5% in January from 1.7% in December. It’s always dangerous to rely too much on any economic numbers that include China’s week-long New Year holiday, but the size of the jump here clearly worried Chinese leaders who made the need to fight inflation a key point in their speeches at the recently concluded National People’s Congress.

  • The Fed isn’t moving to remove stimulus from the financial markets with anything like the speed that the authorities in Beijing are. So far the Fed has decided to stop pumping more liquidity into such markets as that for mortgage-backed securities, but it isn’t actually yet taking steps to pull money out. (For what the Fed has said so far on this see my post )  China, on the other hand, has already started to increase the reserves that banks must keep with the People’s Bank of China.

  • The U.S. economy is the only game in town if China slows. If growth in China drops to, say 7% from the 10.7% th3 country recorded in the fourth quarter, its stock market will tumble. And so will the stock market of every other developing economy. They’re all seen as dependent on China’s rate of growth. (Why this should be seen as true for India escapes me, but the Indian market moves with China’s.) U.S. stocks won’t jump for joy but the U.S. economy is one of the world’s least dependent on exports and the U.S. domestic market is so large that it isn’t as strongly correlated with China’s economy as, say, Brazil is.

  • Finally, the U.S. economy is out of sync with the economies of the developing world. For much of 2009 that was a handicap as growth picked up in the economies of developing Asia much faster than it did for the U.S. economy. Now the U.S. still accelerating (probably) while the governments of China, India, Brazil, etc. are looking to cool growth in those economies. The U.S., of course, isn’t going to grow as fast as even a slowing China, but since stocks trade on expectations, the direction of any change in growth rate is more important at this point than the absolute rate itself.

This comparison doesn’t guarantee the out performance of the U.S. market in the short term. As I pointed out in my latest revision of “How to worry” ( ), an unexpected slowdown in U.S. growth in the first quarter—to be reported in late April—would almost certainly stop any U.S. rally dead in its tracks. But short of that kind of surprise, I think the U.S. stock market is the best in the world for three to six months.

So what stocks would I look to add to my portfolio if I needed to add just a bit more U.S. spice to the stew?

I’ve got three suggestions.

Fluor (FLR). The engineering and construction company recently cut its guidance for 2010. Order backlogs been on a downward trend through 2009. And the company reports that customers are still reluctant to sign on for work. All this means that Fluor is ideally positioned to take advantage of an improving U.S. economy where industries such as the utility sector have huge backlogs of work that they put off in the down turn.

Metropolitan Life (MET). The company has just purchased American Life Insurance (ALICO) from American International Group (AIG). This purchase of one of the international crown jewels in the American International Group portfolio is Metropolitan Life’s reward for playing it conservatively in the run up to the financial crisis. Metropolitan Life is getting ALICO for a price that’s roughly in line with that of a U.S. life insurer but ALICO’s growth rate and opportunities are much greater given the company’s position in China, India, and the rest of Asia.

Union Pacific (UNP). As Warren Buffett said when he bought all of Burlington Northern Santa Fe, a rail road, especially one of the few transcontinental North American railroads is a bet on the U.S. economy.

Which one to buy? If you’re pretty much fully invested and just want to try to add a bit of U.S. dash to your portfolio, go with the stock with the most momentum in this group, Union Pacific. I’m adding that to Jubak’s Picks today. I’ll post a more detailed buy later today.

If you’re looking for more of a value play that might take longer to generate momentum, go with Fluor. Metropolitan Life should rebound with the U.S. financial sector as a whole so if you think you’re underexposed to that sector, it’s a good choice. Both Fluor and Metropolitan Life has enough exposure overseas to give them some legs when U.S. stocks start to fade.

I’m going to add these last two, Fluor and Metropolitan Life, to Jim’s Watch List with this post.

Full disclosure: I don’t own shares of any company mentioned in this post.
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