The short-term uncertainty in the financial markets is likely to rise, and investors will likely be looking to raise liquidity, especially given the continued turmoil in the Middle East and North Africa and the trade deficit hiccup in China. That said, we do not expect the engine of global growth to stall anytime soon. We would view weaknesses in the equity markets as buying opportunities.
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Corporate profits for firms in the S&P 500 have marched upward for six straight quarters from early 2009. Indeed, with the reports almost all in for the fourth quarter of 2010, corporate profits advanced 38% from the prior year. With this growth in earnings, we believe the value of equities remains attractive at 13.6 times forward estimated earnings.
Inflation in emerging economies will remain a concern in the near term but could peak much sooner than expected as tighter monetary policies take hold. The rise in input costs around the globe could potentially impact profit margins; however, low wage growth, positive operating leverage and modest pricing power likely will buffer the downside in most sectors.
Municipal securities continue to provide yields in excess of Treasuries, despite their tax-favored status. For tax-exempt accounts, we continue to see opportunities in corporate debt, both investment grade and the highest quality non-investment grade, as well as in select international sovereign debt issues.
Despite the natural volatility of the stock market, three themes unfolding over the next decade should benefit equity investors: innovation in technology, healthcare and energy; the rise of developing nations and their demand for consumer goods; and global expansion of trade in goods and services.
The combination of an enhanced European-level policy response, fiscal austerity and structural reform at the national level, plus a more broad-based and secure economic recovery, should bring normalization to the Euro-area sovereign debt crisis by 2012. But if one or more of these expectations is not realized, the crisis may intensify.
We recently have taken an increasing interest in housing and housing-related investment opportunities. While we cannot state with certainty when the recovery will come, we see a road towards redemption and investment opportunities while the market gradually improves.
It is our view that inflation should be moderate over the near term. However, we recognize that portfolios of different investors have different sensitivities to sharp increases in inflation. To that end, the discussion here centers on methods to hedge unexpected inflation in those specific portfolios.
We believe one of the most important economic developments to monitor is whether the U.S. economy can wean itself off government stimulus before bond vigilantes take the matter into their own hands. In short, we are in the midst of a cyclical recovery that could be overshadowed at some point by the longer term structural challenges.
Euro area countries need to coordinate their economic policies better to prevent macroeonomic imbalances. The proposed set of policy indicators would identify such imbalances and indicate action to be taken if thresholds are too high or low. But this system has structural problems related to timing, response and proactive planning.