Wednesday, October 6, 2010

For the U.S. it looks like Bill Gross was Right: IMF Forecasts "The New Normal"

Long time readers are probably sick of my harping on a few subjects i.e. Index Construction, Secular Bear Markets and Deconstruction of Equity Market Returns (Equity risk Premium).
I'll try to explain, in a (very) short post, why you are subjected to one or another of these topics on a weekly basis.

Deconstructing returns: 
The major components are growth of earnings, P/E expansion or contraction and dividends.
By definition the aggregate top-line growth of corporations equals the growth of the economy. Profits from those revenues can grow faster because of economies of scale, cost cutting and capital investment.
These productivity gains all eventually reach a point of diminishing returns. The rate of profit growth from cutting employees is the most obvious, you run into a reductio ad absurdum pretty quick= "If we fire everyone our growth will be infinite".

Index Construction: 
All the major indices, even the broadest, miss the growth of private companies which are generally smaller and often faster growing. This is why venture capitalists plow this field.

Secular Bear Markets:
The key here is compression of P/E ratios. We are fairly deep into a cyclical bull contained within a secular bear. Even if companies can grow earnings, the price the market pays for "E" declines over the course of the bear.

All of which makes this forecast important and a bit scary for anyone with an intermediate term view. From Real Time Economics:

 Chart: The IMF’s New Growth Projections
Global growth will slow sharply, more than expected from an already sluggish pace, as advanced economies slash their budgets amid the sovereign debt crisis, the International Monetary Fund said Wednesday.
Growth prospects for the U.S. took the IMF’s biggest downgrade, falling to 2.3% from a previous estimate of 2.9%. China’s growth is still expected to decelerate slightly in 2011, to a still-steamy 9.6%, from 10.5% expansion this year.
Here is a look at forecasts for various large economies, and how the forecasts have changed since the IMF’s July forecasts.
Country 2009 2010* 2011* 2010 projection change** 2011 projection change**
World Output -0.6 4.8 4.2 0.2 -0.1
U.S. -2.6 2.6 2.3 -0.7 -0.6
Euro Area -4.1 1.7 1.5 0.7 0.2
Germany -4.7 3.3 2.0 1.9 0.4
France –2.5 1.6 1.6 0.2 0.0
Italy -5.0 1.0 1.0 0.1 -0.1
Spain -3.7 -0.3 0.7 0.1 0.1
U.K. -4.9 1.7 2.0 0.5 -0.1
Japan -5.2 2.8 1.5 0.4 -0.3
Russia -7.9 4.0 4.3 -0.3 0.2
India 5.7 9.7 8.4 0.3 0.0
China 9.1 10.5 9.6 0.0 0.0
Brazil -0.2 7.5 4.1 0.4 -0.1
*Projected growth **Change in IMF’s October forecast growth rate vs. its forecast in July Sources: WSJ Research
One of these days we'll take on Capital Deepening, for now I have to see how yesterday's short of First Solar is acting.