Kristina Hooper, CFP®, CAIA, CIMA®, is US head of investment and client strategies for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
We're just four months into 2013 and the S&P 500 has posted a year-to-date total return of 11.65%. That's certainly a nice return and yet the general sentiment among equity investors is far from positive. They're uneasy. They lack conviction. And they're waiting for a correction. Investors' lack of faith is evident in their behavior, bidding up defensive stocks—health care and utilities—while shunning cyclicals.
An even larger group of investors believe they have missed the multi-year rally and are hesitant to get in near the top. Symptoms of this sentiment can be seen in equity mutual fund flows, which remain tepid. For the first three months of 2013, we saw less money going into stock funds than bond funds: $79.7 billion in net flows have gone into stock funds (including both domestic and international) while $81.2 billion in net flows have gone into bond funds (including both taxable and tax free.)
Worries about the sustainability of the current rally are perhaps justified. The initial estimate of first-quarter GDP growth, at 2.5%, came in well below expectations. This disappointment was compounded by whispers that first-quarter growth will be “as good as it gets” for 2013 given reduced government spending and slow strides in the labor market.
On top of the macro issues, corporate earnings also pose a challenge. It was a big week for earnings reports but the news wasn't all good. While 73% of companies reporting earnings have exceeded mean expectations, only 44% of S&P 500 companies have reported revenues above the mean estimate. This statistic is disappointing given that, over the past four years, 57% of companies beat mean revenue estimates.
But there is an old adage used by athletes and dieters alike that is fitting for today's investor: “If it doesn't hurt, it's not working.” Investors feeling uneasy about stocks, despite strong performance, may be a sign that this bull-market rally has legs. Historically, when investors have been decidedly bullish on the stock market, it has signaled a top.
Stocks for the Long Run
But what about all those investors who haven't moved back into equities yet and are asking if it's too late to get in? Well, it's never too late if your time horizon is long, especially if you dollar cost average. Stocks, despite their volatility, arguably have a more attractive risk/reward profile today than other asset classes. Here are five key reasons to own stocks for the long term:
- The current forward 12-month P/E ratio for the S&P 500 is 13.9, which is below the prior 10-year average forward 12-month P/E ratio of 14.2.
- Companies have cut costs and are realizing far greater operating efficiencies. In addition, they are enjoying lower debt-servicing costs. That’s why they’ve been able to overwhelmingly meet or beat earnings estimates despite top-line growth that has underwhelmed. So while it may seem like a negative sign to have lackluster top-line growth, it is encouraging to see companies achieve operating efficiencies. It indicates that they will be well positioned to weather economic downturns.
- For calendar year 2012, S&P 500 companies paid out $310.5 billion in dividends, which is a 10-year high for trailing 12-month periods. What’s more, dividends are experiencing year-over-year growth of 15.9%. With dividends still offering tax advantages over other sources of income, dividend-paying stocks look attractive.
- Inflation has been modest, but history has shown that significant stimulus tends to result in substantial inflation. Stocks have typically held up well in inflationary environments, particularly dividend-paying stocks, which have grown their dividends, on average, a percentage point higher than the consumer price index (CPI). Research conducted by Allianz Global Investors shows that, as long as inflation is below 4%, stocks produce positive real returns
- It looks like the Fed will maintain an accommodative stance in the near term. Government-spending reductions are slowing the economic recovery, which was reflected in the weaker-than-expected GDP growth. While slower progress is not good for the economy, it bodes well for a continuation of “easy money” policies. With the recovery unsteady and unemployment high, the Fed is unlikely to reduce its asset purchases or increase interest rates any time soon. Despite the substantial run-up in equities over the past few years, long-term investors should benefit from significant exposure to stocks. For now, central-bank intervention continues to make it even more sensible to stick with stocks.
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