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VOL. 126 | NO. 247 | Tuesday, December 20, 2011

David Waddell

Golden Oldies Drown Out Euro Pop

By David Waddell

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The pendulum swings regarding Europe’s fate continue to relentlessly influence daily market direction. With the European debate drowning out all other market news, relevant economic releases and corporate earnings results have gone unheard. This week, let’s turn off the European pop and listen to some golden oldies.


Reports of the death of the American economy have been greatly exaggerated. In fact, the real U.S. economy has now overtaken its 2007 high. Job gains have been the major challenge, but the data stream has improved. We ended 2010 with an unemployment rate of 9.4 percent, and we ended November 2011 at 8.6 percent. These absolute levels are atrocious, and the speed of gains disappointing, but the trend indicates improvement.

The IMF predicts world GDP will grow 4 percent in 2011 and in 2012. Don’t they know that the world can’t grow if Europe shrinks? The forecast projects growth contracting in Europe, but expanding in the U.S. and Japan. Emerging market growth will still contribute mightily in 2012.

So according to the IMF, the global GDP growth rate can maintain altitude without Europe. The OECD concurs. While I am not certifying these projections, I am demonstrating that Europe’s economy does not represent the world’s economy. In fact, Europe traditionally detracts from global growth. If China moves from speed to stall, then that will be a larger issue. Currently, the IMF forecasts growth for China to will remain near 9 percent.


With global GDP expanding in 2011, there have been plenty of profit-making opportunities. For 2011, earnings across the S&P 500 will grow 16 percent over 2010, 6 percent above record levels. Paradoxically, earnings performance has had little correlation with stock performance. There are 10 sectors within the S&P 500. Earnings across the top 5 sectors grew 20 percent faster than the bottom 5, yet the bottom 5 returned 5 percent more for investors. In 2011, earnings didn’t drive market performance, sentiment did.


There are lots of sentiment indices that investors pay attention to, but the multiple that investors place on earnings (the P/E ratio) proves the most comprehensive. Last year, the S&P 500 closed at a P/E of 15. 2011 will end with a P/E of 12. So even though earnings have grown 16 percent, pessimism has grown 20 percent, forcing markets lower.

How pessimistic is 12? Going back 25 years, the most optimistic multiple that investors placed on S&P 500 earnings was 30; the most pessimistic multiple was 11.5. Roughly applying these bookends to today’s earnings implies euphoria near S&P 3000 and despondency near S&P 1000. At S&P 1215 we are 11 percent above despondency and 89 percent below euphoria. Using the last 25 years for reference, does that feel about right to you?

No one knows whether we will have a financial crisis in 2012. What we do know is that we have had a confidence crisis in 2011. My wish for investors this holiday season is that Santa fills stockings with optimism.

David Waddell, who is regularly featured in the Wall Street Journal, USA Today and Forbes, as well as on Fox Business News and CNBC, is president and CEO of Memphis-based Waddell & Associates.

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