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http://askmerrill.ml.com/example/display/1,,589,00.pdf
Strategy Focus
United States
• Like a broken record, our Sell Side Indicator keeps
playing the same tune. The latest reading is 68.2%, up
from 67.6% a month ago. That means that Wall Street
strategists, as a whole, think that 68.2% of a balanced
portfolio should be in equities and that this is one of the
best times to invest in stocks in the past 16-to-17 years. We
interpret the indicator on a contrary basis, and we note
that it remains deep in “sell” territory.
• The Sell Side Indicator’s current reading suggests that the
stock market’s total return will be roughly –16% during the
next 12 months. That may be too pessimistic, based on the
positions of some of our other measures. Nonetheless, we
continue to recommend a conservative asset allocation mix of
50% stocks, 30% bonds, and 20% cash. Our baseline mix is
60% stocks, 30% bonds, and 10% cash.
• Interest rates, inflation, and earnings are three of the
key variables in investors’ market-valuation models. It’s
no surprise that interest rates and inflation are low and
that models that rely on those data show that the market
has already discounted the “good news” on those fronts.
We think that investors should focus on earnings. When
they do, they’ll find that earnings growth is the least
predictable it has been in more than 60 years. In that
uncertain environment, how much faith can investors
have in optimistic earnings forecasts?
• We measure earnings volatility by taking the year-to-year
growth rate in S&P 500 reported earnings for each quarter in
a three-year period and calculating the standard deviation of
those 12 numbers. Right now, the standard deviation is the
highest it has been since 1941.
• Such a high level of volatility might be a good thing if
investors were understating the earnings power of the S&P
500; under that assumption, there would be a good chance
that the range of outcomes would be skewed in a positive
direction. Unfortunately, our earnings measures suggest that
the opposite is the case: earnings do appear to be improving,
but not as quickly or as strongly as the consensus expects.
• We continue to overweight consumer-staples stocks
because we think that earnings estimates for many
companies in the sector are generally too low at a time
when the consensus is overestimating the earnings power
of the S&P 500. If we’re correct, that means that the
sector’s valuation is lower than most investors think it is.
• Meanwhile, investors might do well to consider this: the
consumer-staples area no longer appears to be a
homogenous sector. Instead, as we see it, the sector is
made up of two disparate groups: the food chains and
drug stores on the one hand, and the multinationals on the
other. That’s important, because the investment themes
for the two groups differ markedly. In our view, the
multinationals are more cyclical than most market observers
think they are. It follows that investors who believe that
global growth prospects will continue to improve might think
that the consensus is underestimating the earnings power of
the multinational companies. By the same token, investors
who do not expect global growth to improve might prefer
food chains and drug stores, which generally have no foreign
exposure and which tend to be more stable and defensive than
multinationals.
Richard Bernstein
Chief U.S. Strategist
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