The U.S. stock market not only provided protection relative to the BRIC markets during the bear market, but it has also maintained that outperformance during the bull phase. In addition, U.S. free cash flow yields are now between 7% and 8%, and emerging markets (EM) free cash flow yields are less than 3%.
During the 10th annual Dow Jones Indexes Global Economic Outlook, Richard Bernstein, chief executive officer of Richard Bernstein Advisors, outlined these additional investment themes from his firm’s research for 2012:
- Overweight of smaller U.S. stocks, with an eye for smaller, domestically-oriented financials. The best secular investment theme in the global equity markets is U.S. small cap stocks, Bernstein said, adding that investors seem to be overlooking smaller U.S. companies’ fundamentals. Some are concerned about the valuations of smaller capitalization stocks but must keep in mind smaller companies’ earnings potential. Smaller companies’ stocks are typically volatile, but despite the volatility during 2011, the Russell 2000 has outperformed the MSCI Emerging Market Index by about 10% during 2011.
- Underweight commodities and gold for U.S. dollar investors. Overweight for EM currency investors. In general, real assets tend to perform well during periods when a currency is depreciating and inflation expectations are rising. This is not happening within U.S. dollar markets, but it is happening in other currencies. Although gold returns in U.S. dollars peaked earlier this year, returns in EM currencies continue to rise. Gold has, to some extent, beat the negative trend in other commodity prices, which Bernstein said makes little sense because the dollar is not depreciating, nor are inflation expectations rising. Real asset prices such as housing and commodities have depreciated, unlike gold, but Bernstein thinks gold prices will not be far behind.
- Positions on treasuries to maintain portfolio diversification. Bernstein describes U.S. treasuries as perhaps the most misunderstood asset class. Treasuries is the only major asset class that currently provides diversification to a multi-asset portfolio. Some investors have been weary of treasuries because of their low yields, but Bernstein explained that treasuries always have relatively low yields. Treasuries’ lower yields have actually increased their diversification potential. As yields fall, treasuries’ duration increases (they become more rate sensitive). Smaller amounts of treasuries therefore can be used to diversify portfolios without losing effectiveness.
- Increasing avoidance of alternative assets. According to Bernstein, few investors realize that most alternative assets’ returns are credit-dependent, and that these asset classes’ outperformance was largely driven by the bubbles’ increasing availability of credit. Because the global credit bubble continues deflating, Bernstein thinks investors’ expected returns for alternative asset classes may be too optimistic.