Friday, January 6, 2012

Readers Challenge Random Glenings

I have received a few comments recently from loyal readers of Random Glenings.

As might be expected from such an elite group, their thoughts have been very insightful and challenging, so I thought I would mention them today.

"Isn't everyone bearish on the financials?"

I wrote a long piece yesterday discussing why I remain very worried about the prospects for the financial sector.  However, one reader called to suggest that this is  a consensus view.  Moreover, with valuations of many bank stocks at record lows, one could argue that a lot of the "bad news" has already been priced into the stocks.

I, too, have seen the surveys that indicate that the single most disliked group is the financial sector. However, my contention is there is still a significant difference between what investors are saying and how they are investing.

At the height of the financial crisis, financials represented 9% of the S&P 500.  Today this number is 14%, which makes it the second largest sector (by market capitalization) in the S&P after the technology group.  True, financials represented more than 20% of the market in 2007, but I would argue that this just meant that they were overvalued 5 years ago.

Put another way:  someone must be buying the stocks.

"You're wrong on Europe and the Emerging Markets. European stocks are trading at very cheap levels relative to the US.  And growth rates in the emerging markets will rebound in 2012, and the stocks do not yet reflect this. You should be adding more international exposure in your portfolios."

This is a tougher one to challenge.  Even though US market returns were flat last year, they far outperformed international (-12% in 2011) and emerging markets (-13%).  If the euro crisis can come to some sort of resolution, European stock markets could surprise on the upside.

Emerging markets could also be a surprise this year.  Recall that a year ago most of our concerns were about inflation in countries like China and Brazil due to their extremely fast rates of growth.  Governments acted to tighten credit to slow the rates of growth in many emerging markets countries, and were largely successful.  Thus it was not surprising that the emerging markets stocks followed.

I think I need to do more work on international stocks in the next few weeks.

"Your generally positive stance on healthcare stocks is misguided.  Government spending on Medicare and Medicaid has to slow meaningfully if the federal deficit issues are to be addressed, and this will weigh heavily on the group."

I attended a health care forum yesterday sponsored by Citigroup which featured 8 different analysts from all of the various healthcare sectors.  With the exception of one analyst - who specialized in healthcare IT - all were neutral or negative on their outlooks for 2012.  The single most cited concern was cutbacks in Government spending.

I am not disputing that health care costs are the single biggest issue that needs to be addressed if we are to make any headway on reducing the federal deficit.  The numbers are indisputable; at the current rate of growth (+8% per annum), health care costs will soon overwhelm every other category of federal spending.

My question is timing.  In an election year, it seems unlikely that either political party will do anything to offend older voters.  Moreover, while many agree that health care spending is out of control, there is little consensus on what exactly should be cut.  I don't believe that much will change until it becomes absolutely necessary, which means that true health care reforms will not take place for at a few years at least.

Healthcare stocks are generally trading at inexpensive levels, and many pay attractive dividends.  These two qualities will keep the sector buoyant in 2012, in my opinion.