Saying good-bye to 2011 has been an easy thing to do. It was another tough year for the financial markets, fraught with fear and doubt. Uncertainty in Europe and the United States, a tsunami in Japan, slowing emerging markets, and downgrades of U.S. and European debts were just some of the major worries. Read more >> The market careened like a roller coaster; up in the beginning of the year to a major correction in the fall. With all the turmoil, the S&P 500 ended the year +2.2% with dividends, while the 10-year Treasury bond yielded a meager 1.87%.
As we begin 2012, many of the worries from 2011 join us. The United States will most likely grow, but at a pace so slow as to feel almost like we are in a recession. Europe remains a wild card and the market’s current upward movement suggests it has not accounted for a negative surprise overseas.
At home all eyes will be focused on Washington as we struggle with debt ceilings and anticipate the outcome of a presidential election in November. In turn this means that uncertainty will continue to be a theme in the markets as investors lack the confidence to forecast not only the earnings, but what multiple should be paid for those earnings. Historically, given the current low levels of interest rates and inflation, it would be correct to expect a multiple of 18x earnings. However, the uncertainty as to whether the S&P will be able to achieve these numbers in a slow growth environment, leads us to believe that the multiple could actually be in the range of 11x to 15x.
There are, however, 2 macro themes where we do find high levels of conviction. The first is a global deleveraging as governments worldwide and individuals (especially here in the U.S.) begin to focus more on paying down debt and saving. A recent study by McKinsey (http://www.mckinsey.com/Insights/MGI/Research/Financial_Markets/Uneven_progress_on_the_path_to_growth) talked about the deleveraging process that occurred in Sweden and Finland in the 1990’s. They noted that in the first phase of the deleveraging process, economic growth is negative or minimal and government debt rises. This phase can last several years. It is our expectation that we will experience that same process here in the United States, especially a slow growth environment, for several years.
This leads us to our second macro theme, which is that in this scenario, dividends will continue to be an important source of return and yield. In 2011, nearly 100% of the S&P return was attributed to dividends. According to S&P, dividend increases reached $50.2 billion in 2011, an increase of 89.2%. In our portfolios, 25 of our 29 stock holdings have increased their dividend, with the average increase being over 10%. With corporations continuing to hoard cash in this uncertain climate, we expect these strong dividend increases to continue. S&P notes that dividend payout ratios are currently near their lows at under 30%, compared to an historic average of 52%. At CAIM, our focus will continue to be on cash rich companies with the capacity to increase their dividends to those historic norms.
We look forward to working with you in 2012. Our best wishes for a healthy, joyful and prosperous year ahead!