The Fundamentals of Recoveries (October 2010)
Commentary on the health of equity markets today and the perils of investing while looking backwards. Will McKenna interviews Tim Armour and Jim Dunton, portfolio managers, with Capital Research and Management Company.
Featuring:
Tim Armour, Portfolio manager, Capital Group*
Jim Dunton, Portfolio manager, Capital Group*
*Portfolio manager with Capital Research and Management Company; does not manage Capital International portfolios.
- Recovery off to a slow start - but it’s just the start (VIDEO, 5:12)
- The perils of investing while looking backwards (VIDEO, 3:04)
- Opportunities across a wide swath of companies (VIDEO, 3:29)
- Strong corporate fundamentals an encouraging sign (VIDEO, 3:01)
- Reflections on the presidential cycle (VIDEO, 1:53)
You may watch all of the above videos by clicking HERE, or on the image below. To view all 5 chapters visit "Select Chapter."
The fundamentals of recoveries
by Capital International Asset Management
1. Recovery off to a slow start — but it’s just the start
Craig Strauser: Hello. I’m Craig Strauser. Welcome to this edition of Capital International Perspectives. In this program, you’ll hear the latest insights from veteran portfolio counselors Tim Armour and Jim Dunton. When my colleague Will McKenna sat down with Tim and Jim to talk about market recoveries, the topics ranged from company fundamentals and investment opportunities today to presidential cycles and the tendency of investors to gaze into the rearview mirror when calculating their next move.
To start things off, Will asked Jim and Tim to assess the current recovery.
Will McKenna: Let's start by talking about the current investment environment. Jim, you've invested through a number of full market cycles in your more than 40 years in the business. How would you characterize where we are at this stage of the recovery, and where do you see us going from here?
Jim Dunton: There’s a large body of economic evidence on a worldwide basis that any kind of recession that emanated from a financial crisis [like the one] that we’ve just gone through was going to evolve into a deeper recession than any that we would typically experience; there would be a longer recession than any that you typically experience, and, what’s more, the recovery itself would be much slower than normal.
Well, that’s exactly what we’re going through. We now are one year into the [U.S.] recovery, and it’s been very slow — like 3% real GDP. But it’s also important to bear in mind that it is underway. And once recoveries get started, they typically go a long time. The last cycles were seven years, 10 years, nine years; the one before that, eight. The typical cycle is seven to 10 years long, not one year long. So, one year into the recovery — which is where we are now — is not exactly the time to get overly concerned that the recovery has ended. We, in fact, just started.
But I think if you look also at the details, you would feel comforted by the fact that [U.S.] employment is, in fact, gaining ground; it has been all year. The number of hours that are worked is increasing. The number of people employed is increasing. And, importantly, the temporary workers are probably up sixfold from what they normally are in a recovery, which means that a lot of companies are hiring temporary people until they find out what the full status of the current economic programs are, the stimulus programs, the tax programs, the health programs — as to what all that is going to cost corporations before they want to fully employ people.
We’re through, I think, the worst of the recession, and we’re in a recovery mode, which I believe, from my point of view, is going to go on for the next eight or 10 years. So, I think we are slowly gaining ground — slowly gaining ground — but gaining ground nonetheless.
And it’s important that you recognize that what the end of the cycle looks like is more inflation [and] higher interest rates; that’s the typical end of a cycle many years from now. But it does suggest that between here and there are rising corporate profits, rising inflation, rising interest rates and probably a very healthy stock market over that period.
Tim Armour: The overarching issue, I really think — as with any recovery — is that it will be an up-and-down process. There’ll be bits of information or bits of data that come out that are either positive or data that appears that we’re either slowing down again or retrenching, which looks negative. I think one really has to keep an eye on the long run and see what’s happening with corporations, what’s happening with consumers. In the U.S., there’s been a reliquification on the consumer end of things. Consumers went into this period pretty indebted. The savings rate is up a lot in short order, and consumer spending — although not strong by any definition — certainly has maintained a reasonable level.
At some point here, we need to see employment growth in the U.S. pick up and consumers return to spending at a somewhat higher rate if we’re going to really see GDP [gross domestic product] growth here in the U.S. be stronger. But my expectation is that will happen ultimately; it’s more a question of time. And looking at past cycles, you can find any experience along that spectrum of either a more rapid recovery or a slower one. Having lived through some of these in the past, I think, makes us more comfortable that, really, the way to invest in this kind of period is identify the best companies out there, with good fundamentals, and don’t worry so much about the economic backdrop.
2. The perils of investing while looking backwards
Will McKenna: Given what they’ve been through over the past couple of years, a lot of investors are nervous about putting their money in the stock market today. What perspective could you offer, given your experience, about the wisdom of investing in stocks in this environment?
Jim Dunton: Cycles generally develop as I’ve outlined, and that is that you go from paranoia and fear through the evolution of employment growing again, of business getting back together, of resources being used up. And as they’re used up, inflation appears, and the [U.S.] Fed needs to control that. The standard cycle — it’s happened that way every time. There’s no reason to expect this time to be any different.
It is true, of course, that in the last 10 years, the average investor has been hit by two terrible recessions and two very significant stock market declines. It’s enough to scare the average person, for sure. And in the current period, of course, there’s just a plethora of commentary about the difficulty of getting the economy going, of the difficulty of getting people back to work and so forth. But that happens every time. That is what the bottom of a recession — the early part of the recovery — looks like. So, it doesn’t feel any different to me, having been through a lot of them.
Stock market participants are generally always chasing the last good story. And, of course, the last good story is the [U.S.] bond market — which, in fact, has had positive returns for the last 10 years and the equity market has not. Unfortunately, people seem to invest by looking in a rearview mirror. And that’s very unfortunate, because we saw the same thing happen in the period in the late 1990s in the tech blow-off, or in the Nifty Fifty in the 1970s, in the oil run-up in the 1980s. I mean, all these things were chased by people looking backwards.
