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The Sandy Spring Way

It’s about time.

September 10th, 2012 | By Beau Mercer

Believe it or not, the U.S. stock market as measured by the S&P 500 index hit an all-time record high last week when you include reinvested dividends, according to Bloomberg. Now, you may not have seen that headline in the news last week because the index itself is still 9.3 percent below its all-time high reached on October 9, 2007.

Here are a few other interesting stats to ponder:

  1. In 2012 alone, the rise in the U.S. stock market added $1.9 trillion to investors’ wealth.
  2. As of last week, the S&P 500 index rose 112 percent from its 12-year low reached in March 2009.
  3. Even though economic growth is sluggish, U.S. corporate earnings are projected to reach a record high this year. If reached, this would place earnings about 20 percent higher than 2007’s – the year the U.S. stock market hit its all-time high.
  4. By historical standards, “The S&P 500 is trading 13 percent below its average valuation since the 1950s.”
  5. World central banks expanded their balance sheets by about 9 trillion dollars since the financial crisis started.

Sources: Bloomberg; Barron’s

Number 5 above is an important point to keep in mind. Easy money has greased the world economy and now there’s talk of even more monetary stimulus in Europe and the U.S., according to MarketWatch. What remains unanswered is, how much of the market’s rise has been stimulated by the stimulus and what happens when the stimulus is no longer available or effective? Can the economy stand on its own?

Barron’s framed it this way, “At some level, the market gets priced not simply for the monetary-easing cure to remedy economic ills, but for that drug being administered to a healthy patient for recreational purposes.” Translation – if central banks overshoot and markets get addicted to the easy money high, the inevitable withdrawal of the money drug may be painful.

Data as of 09/07/12 1-Week YTD 1-Year 3-Year 5-Year 10-Year
Standard & Poor’s 500 (Domestic Stocks)

2.2%

14.3%

20.0%

11.9%

-0.2%

4.8%

DJ Global ex US (Foreign Stocks)

2.7

6.9

1.0

2.0

-5.3

6.7

10-year Treasury Note (Yield Only)

1.7

N/A

2.0

3.5

4.4

4.1

Gold (per ounce)

4.8

9.8

-4.5

20.3

19.8

18.3

DJ-UBS Commodity Index

0.8

4.7

-9.3

5.5

-2.5

3.3

DJ Equity All REIT TR Index

1.6

19.3

23.1

25.9

4.3

11.4

Notes: S&P 500, DJ Global ex US, Gold, DJ-UBS Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; the DJ Equity All REIT TR Index does include reinvested dividends and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods

Sources: Yahoo! Finance, Barron’s, djindexes.com, London Bullion Market Association
Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. N/A means not applicable.

CAN GOOD NEWS BE GOOD FOR THE WRONG REASON?

Typically, strong economic growth translates into rising corporate profits. Rising profits, over time, tend to lead to rising stock prices – or so one would think.

Consider China. For many years we’ve heard how China is supplanting the U.S. as a manufacturing and economic powerhouse. And, in many respects, it’s true. Between 1989 and 2012, China’s gross domestic product rose at an annual rate of 9.3 percent – dramatically above the growth rate in the U.S. – according to Trading Economics. Today, China has the world’s second largest economy and it’s projected to overtake the U.S. in just four years, according to the International Monetary Fund as reported by BusinessWeek.

So, yes, China is an economic powerhouse. But, has their economic growth translated into stock price growth?

Let’s go back about 12 years, November 10, 2000 to be exact, and see how the Chinese stock market has performed as measured by the Shanghai Stock Exchange Composite Index. The Shanghai Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange.

Back on November 10, 2000, the Shanghai index closed at 2,047, according to data from Yahoo! Finance. Now, almost 12 years later, where do you think the Shanghai index closed last week?

Shockingly, the Shanghai index closed at 2,047 – exactly the same price as it was nearly 12 years ago! This flat stock market performance occurred despite the fact that the Chinese economy grew by more than 500 percent between 2000 and 2011, according to The World Bank.

Now, before we conclude there’s no connection between economic growth and stock prices, we have to go back even further. On December 19, 1990, the Shanghai index was created with a starting value of 100. At last week’s closing price of 2,047, this means the Chinese stock market, as measured by the Shanghai index, has risen more than 1,900 percent between 1990 and 2012. On an annualized basis, that’s more than 14 percent per year – an exceptionally high return.

Okay, after all these numbers, what can we conclude? A couple things:

  1. Fast economic growth in any given year does not necessarily translate into rising stock prices that year.
  2. Fast economic growth eventually shows up in stock prices, although some of the growth may be “pulled forward” and “priced in” to stocks well ahead of when the growth actually occurs—as happened in China.

This lack of a linear relationship between economic growth and stock prices is one more variable we have to consider when developing portfolios.

Weekly Focus –Think About It…

“Laziness may appear attractive, but work gives satisfaction.”

Anne Frank, The Diary of a Young Girl