The big question in the
Investors only want to know one thing: What's next?
To the degree that such a question is answerable, one must consider
1. The historical underpinnings
The long-term ability of the market to generate returns suggests
investors can expect an annualized gain of 9.43%, which assumes
that all dividends are reinvested. This is the total return of the
S&P 500 since 1965, which I cribbed from inside the front cover
Berkshire Hathaway (NYSE:
. The best year during this time period was 1995, with a 37.6%
gain, and the worst was 2008, with a -37.0% loss. The average was
In the 1970s, the market managed a compound annual growth rate of
5.78%, in the 1980s: 17.4%; and in the 1990s: 18.2%. That rate of
return slipped into the negative in the first decade of the 21st
Century, as the S&P 500 saw a three-year run of debilitating
losses. (Anyone who invested $1,000 on Jan. 1, 2000, ended up with
$909.40 at the end of the decade.)
Even so, the average holds, and it holds any way you slice it.
Whether we look at the past half-century as one running block of
time or as four decades (with two outstanding periods, one
lackluster decade and one abysmal 10-year stretch), we still see
that the compound annual growth rate of 9.43% is a good "average"
As 2011 was a subpar year, the historical data suggest 2012 has a
relatively stronger chance of being positive than negative.
Excepting 2001-2003, in the past 10 instances when the market had a
below-average return, the following year it returned an average
2. The fundamental perspective
continues to circle the drain, from a fundamental perspective,
stocks look great. Companies have a lot of cash on hand. Management
has adjusted to the economic realities and
The S&P 500 is trading at an aggregate 13.2 times earnings.
This seems very low.
In the 1990s, investors saw the market valued at 21.3 times
earnings. The next decade, that fell a little, to 19.6, but it was
still a nice "new normal" compared with what investors had grown
accustomed to in the 1970s and 1980s, when the average earnings
multiple of the market's benchmark average hovered at 12.7 and
The 1960s were a little headier: the market's price to earnings
(P/E) ratio was an average 17.6, which seemed like progress from
the 1950s, when it was at about 14. All in all, the average
earnings multiple of the S&P 500 from 1954 to the present is
This works in pretty nicely with the other numbers. It will take a
24.2% gain for the valuation of the
to move from its current 13.2 times earnings to its historical
average of 16.4, which is in line with my conclusion from the
3. The black swan
Anyone who's invested even $100 in the market in the past decade
knows one thing (and perhaps only this one thing) to be true:
Anything can happen. Anything.
The world can change, and it can change overnight. The hell of the
deal is that despite instant communication and better -- or at
least more -- information, we can still be almost absolutely
surprised. Be it an economic calamity like the financial crisis, an
act of God like the earthquake/tsunami that struck Japan, or an act
of madmen such as a terrorist attack or coup d'etat, the markets
are at constant risk of panic. Plus, all markets are interconnected
to a greater degree than ever before, so what once might have been
a bad day in Madrid now becomes an opportunity for worldwide
sell-off. The advent of computerized trading to exploit these
ripples doesn't help anything, at least not for individual
So we may not know what is going to happen, but we have to
acknowledge that some catastrophic event could knock the markets
off kilter. The worst-case scenario at this point, absent a
mass-scale terrorist attack, rogue nuclear launch or natural
disaster, is major trouble in Europe. The looming debt crisis there
and the lack of clarity about the future of the euro means events
could well render any forecast or strategy moot. This cannot easily
be hedged against, but it is a good reminder as you consider your
portfolio allocation for the year. Ask yourself what the risks you
shoulder really are, and if you are comfortable with them.
4. The basic forecast
What will 2012 look like for a major blue-chip U.S. company?
To determine that, we'll take a brief look at venerable consumer
Procter and Gamble (NYSE:
. The company is on track to record $82 billion in revenue in 2011
of about $11.2 billion. With 2.8 billion
, that's some $4.07 in
earnings per share (
are at about $66, so its P/E ratio is 16.2 ($66/$4.07).
What would it take for a company like P&G to see a 24.2% gain?
There are only two answers to the question.
First, it could see an increase in its valuation. As it is trading
at its two-year average, this seems mildly unlikely. However, its
five-year average earnings multiple is 18.1, so assuming a rise in
the overall market, it's not outside the realm of possibility to
see P&G maintain its relative premium. So if our target price
is $82 (current price of $66 times a 24.2% gain) and we assume an
earnings multiple of 18.1, then we'd need to see 2012
of $4.53, which represents an 11.3% increase in earnings.
The trouble is, 11.3% of $82 billion is $9.18 billion. P&G
hasn't posted growth of that magnitude in recent memory. Its more
typical revenue growth rate is in the neighborhood of 2% to 4%, and
it typically operates at a roughly 15%
If it comes, then the growth will likely have to come from Asia,
where P&G is seeing strong growth, in the area of 10% a year.
Last year's sales were $13.2 billion, which grows to $14.5 billion
in 2012 if the trend holds. That helps, but it doesn't quite push
the needle far enough. P&G needs an
to do that -- a new product line that will immediately add to the
company's top and
. It has a very high "AA-"
and several billion in cash on hand, so one major or two mid-sized
acquisitions could do a lot to juice Procter & Gamble's bottom
So, in sum, almost everything has to line up for the company. It
has to maintain current U.S. sales, continue its upswing in China
and manage costs worldwide. The market has to see a premium value
in a stable company, and P&G investors need to count on a
rising tide lifting all boats and that the shares hang on to their
relative premium. That said, a well-conceived acquisition or
stronger-than-expected performance, on top of any sort of economic
recovery, could do great things for these shares. I expect P&G
to keep pace with the overall market.
What then, after all that, is next?
Risks to Consider:
Because the likelihood of a black swan increases the
commensurate chance for volatility, the watchword for the upcoming
year should be caution. Don't be afraid to take your chips off the
table for a while -- even after you reassess your risk tolerance
Action to Take -->
My prediction is that the overall market in 2012 will follow
history and experience a strong year. The average 24.2% return
after a below-par year, however, appears far too rich, especially
for large cap companies like P&G with limited growth ability.
The market's average compound annual growth rate of 9.43% is likely
a far more reasonable expectation.
Disclosure: Neither Andy Obermueller nor StreetAuthority, LLC
hold positions in any securities mentioned in this article.
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