Record-High Profits May Not Last

Corporate Profits Graph

One factor that has buoyed U.S. stocks in recent years is high profit margins. Corporate profits as percent of the country’s total output reached a record level of 10.8% in the first quarter of 2012, and they’ve gone even higher since then. In the third quarter of 2013 (the last period for which numbers are available) they reached a new record of 11%.

Part of the reason for record-high profitability may be the weak jobs market. Higher levels of unemployment since the financial crisis have resulted in less pressure on companies to increase their employees’ wages, leading to lower costs and higher profits.

Some analysts suggest that record-setting profitability is a bearish sign for the stock market going forward, since profits presumably have nowhere to go but down (the long-term average for corporate profits as a percent of the country’s total output is around 6.5%).

This decline may begin as the unemployment rate declines toward more normal levels (it’s now 6.7%, down from a high of 10% in late 2009). That would serve as a headwind for stocks, offsetting some of the benefit from stronger economic growth.

Will Emerging Markets Rebound in 2014?

EmergingMarkets map2013 was generally a good year for stocks, but emerging markets were a notable exception. While global stocks rose 20% during the year, including gains of around 30% in the United States, emerging markets posted negative returns. Whether emerging markets will rebound in 2014 will depend on a few key factors:

  • Economic growth. There is generally only a weak link between economic growth rates and stock market returns, but the unexpectedly sharp declines in growth rates in 2013 for countries such as Brazil, China, India, and Mexico caused investors to rethink their assumptions about the future for these countries. A rebound in economic growth next year would help restore confidence in emerging market stocks.

 

  • Political risk. 2013 was a popular year for protests, with political turmoil contributing to stock market declines in countries such as Brazil, Egypt, Thailand and Turkey. Emerging markets will be in the global spotlight again in 2014, with the Winter Olympics in Russia, the World Cup in Brazil, and national elections in countries such as Brazil and India. Whether political turbulence grabs the headlines during these events will help determine how risky investors view emerging markets to be.

 

  • The outlook for developed economies. When it comes to stock markets, a rising tide tends to lift all boats, though not necessarily at the same speed. In 2013 an improving economic outlook for the US and Europe made emerging markets look less attractive in comparison. Further improvement in developed countries would likely have some positive effect on the growth rate of emerging economies, but it would also further erode the perception that emerging markets are the fast-growing alternative to stagnant developed markets.

 

The Weak Link Between Economic Growth and Market Returns

Globe

 

When deciding where to allocation your investments on a global basis, it’s tempting to look for the fastest-growing economies and put your money there. Yet academic studies have shown that there’s only a very weak relationship between how fast a country’s economy grows and how well its stock market performs.

It may seem counterintuitive, but sometimes stock markets in countries with slower economic growth significantly outperform those in faster growing countries.  This year is a  a prime example. The latest World Economic Outlook from the International Monetary Fund estimates that China’s economic growth this year will be 7.6% while Japan’s will be only 2.0%. With the year almost over, Chinese stocks are roughly flat while Japanese stocks are up more than 20% (in U.S. Dollar terms).

Why don’t faster-growing economies also mean faster-rising stock prices? Part of the answer is that since economic growth can be estimated fairly well in advance, expectations for faster growth may already be incorporated into stock prices. In other words, if you know that one country is going to grow faster than another, it’s likely that someone else figured that out before you did.

Another reason is that some aspects of economic growth may hurt many companies rather than help them. New technological innovations can boost a country’s economic growth rate, for example, but the profits from these innovations could go to new start-ups more than the existing large companies that tend to be listed on stock markets.

The upshot is that pouring money into fast-growing countries (or completely avoiding slow-growing ones) isn’t a good investment strategy. Having a portfolio that’s well-diversified internationally is a better alternative.

The Value of “All in One Place”

All In One Place

These days almost everyone has multiple investment accounts, from standard brokerage accounts to retirement accounts such as 401k’s and IRA’s to college savings plans such as 529’s. Being able to view all of your accounts in one place rather than hopping from website to website or monthly statement to monthly statement can make the process of keeping tabs on your investments substantially easier. But being able to see everything in one place isn’t simply a time-saving trick. It can also improve how you manage your portfolio.

Perhaps the most important benefit is the ability to identify issues across more than one account. Let’s say, for example, that in one of your accounts you own a few stocks in the technology sector. By itself this may not be a problem, especially if this one account is a fairly small portion of your wealth. If your other accounts contain funds that are overweight in technology stocks, however, you could end up with a dangerously high overall exposure to the technology sector.

Whether you’re looking at the breakdown of your portfolio by asset class, region of the world, or economic sector, being able to see all of your accounts in one place gives you the 30,000 foot view that makes it possible to figure out if something is off-course and needs to be corrected. The first step to taking control of your wealth is to be able to see it all together.