r2i forum

Folks,

As we have entered into 2007, I wanted to start a discussion on what is next for global capital markets. The last 4 years (since 2003) have seen steady (U.S.) to explosive (emerging mrkts.) growth in the world's stock markets - in line with solid economic expansion and modest inflationary conditions (tempered by Fed interest rate increases) in many economies.

But, what next? How long will "Goldilocks" stay in the global equity markets? Have we entered a phase of a) stable long term expansion (i.e. Goldilocks is here to stay for a long while) or b) this is just mean reversal (i.e. payback for 2001-02 global rout) with a period of modest decline to follow or c) are the world equity markets looking at an imminent bear in 2007?

Experts and forum 'leaders', please speculate...

Guess no one wants to speculate! :)

KRV;7263Guess no one wants to speculate! :)

Many of us are good students of Desi and Bobus, so won't dare to speculate..:emwink:

VRG;7298Many of us are good students of Desi and Bobus, so won't dare to speculate..:emwink:

Touche! :)

KRV,

From your list probably I would pick choice a
Here are my reasons:
1. In last four years small stocks and emerging markets have returned above 15% although these are considered risky investments. This has also lead to higher PE levels for both these categories. Where as large caps represented by S&P still at the Forward P/E of about 18. But if you see PE levels of China and India markets, they are well above 20. So I think there's room for expansion before S&P reaches 'lofty' valuations. Most of the financial experts are saying that so far the returns of S&P can be related to earnings growth and to less extent due to PE expansion. So this year we should see PE expansion even though earnings growth may slow down.
2. Given the unrealistic levels of valuations reached in the emerging markets and small cap, they might be at the end of thier run. (again I'll be cautious here as experts predicted 2005 was the end of small cap run, which turned out false). I think this was the first year when in-flows in international funds exceeded domestic funds. For me this is a contrarian indicator. If herd goes one way, you go other way
3. Main stream media is still not talking so much about the new heighs being set by Dow or S&P. They are too busy writing/discussing obituary stories related to real estate bubble. Until the focus shifts from real estate to stocks, common folks won't enter equity.I think even so called smart money is not yet fully out of real estate or other exotic investments. For example, you can read daily news about big banks and hedge funds forcing sub-prime lenders to buy back the bonds issued after defaults. That means these guys are deep in this real estate bubble and still trying to pull money out of this. Same thing happened with hedge funds invested in energy sector last year.

Overall I think this will be a good year for large caps (S&P 500) compared to others and EM.

Note: I'm not an expert and considers myself as beginner in the long journey of personal finance PRO :)

Good analysis and thank you for engaging in this speculation. I am of a similar opinion that 2007 may work out to be a relatively steady year of growth, but I believe US may do better than some emerging markets, especially India and China. I feel that a globally diversified equity portfolio may earn a return of 10-15% in 2007, which is quite good.

My speculative analysis also leads me to conclude that bonds will have a difficult year again in 2007, so my bond allocation in my portfolio is underweighted. In the past 2 years, this has served me well and as I was thinking of bringing bond allocation back to my AAP target early this year, I will now defer that till late 2007 or early 2008.

As an aside, I want to point out a 'disclaimer' in light of the "active" vs. "index" discussion going on in another thread. My overweight or underweights in asset classes are done using index funds, not with actively managed funds. I have little faith in the long term outperformance of active funds against a comparable index fund in any asset class.

I am uncertain about 2008. I think by that time, most equity markets would have grown to the point from which a decline may look more likely than further growth. This is especially true if interest rates are raised in the second half of 2007 by U.S. and Europe. Japan and emerging markets like India are also likely to raise interest rates in 2007 IMO.

Business Week recently ran a covery story titled "It's a low, low, low, low rate world" talking about the enormous liquid capital floating in the global markets causing all sorts of speculative activity and potentially fueling the growth in equity markets. The article felt this would continue for years to come. I am not sure about that... although if it is true, it makes the case for underweighting bonds for a long time as a low interest rate environment does not make bonds look attractive.

KRV,

Excellent thread, especially "My speculative analysis also leads me to conclude that bonds will have a difficult year again in 2007, so my bond allocation in my portfolio is underweighted. In the past 2 years, this has served me well and as I was thinking of bringing bond allocation back to my AAP target early this year, I will now defer that till late 2007 or early 2008."

Pls keep us posted so that we can also benefit.

Also, I remember you had mentioned in another thread that you update your portfolio every weekend, has it been posted yet?

thanks.

Heres some comments by Larry Swedroe about recent stock market slide from diehards forum.

[quote]
what we are witnesses is a global repricing of risk.

This is very serious IMO. Will likely be huge losses. Hundreds of billions likely.

And IMO my guess is you will have to see Central Banks intervene flooding markets with liquidity

Here is why. This is how markets work in times like this (the only things about investing you don't know is the history you don't know).

1)We had tight spreads and easy money--risks reduced, at least perception. And then with tighter spreads on risky assets those seeking high returns have to lever up, And liquidity is cheap and available, and that leads to apparently virtuous cycle of ever higher prices and great returns until one day the merry go round stops.

2) Spreads widen and then prices are falling. Now you get margin calls on the collateral from lenders. But there is no price for this junk. So they sell almost any asset and at almost any price. That drives values down even further, leading to more margin calls, etc.

3)Good indicator--today the ECB had to step in and provided huge liquidity to 48 major banks that had no other way to get it. That is what caused market panic. This aint over yet IMO.

Risk is risk period. And those taking more than they should have are going to pay the price. Those that stay the course and did not take more risk than they could or needed to, will have have chance to buy cheap again, once this rout is over.

Just crystal ball gazing
[/quote]

In my opinion we are going to see something between a soft landing and a crash. the signs are here already with the Dow going down and the sub-prime lending crisis. Besides I think things go in cycles. It is a good thing and a bad thing. There can never be unconstrained growth ever in the market. A simple analogy - if it is a festival time - diwali or whatever and you have a big feast and gorge yourselves , the next day it is quite likely that you wont be in a position to gorge again and may be eating light. Same with the economy.

I try not to think too much macro (and much less act on it), but...

I think a more helpful way to think about current valuations and return expectations is not to think in terms of bonds vs stocks but think in terms of leverage and risk. The orgy of risk taking in the last few years has extended the valuations of assets that are risky to a point where the risk premium for that asset is razor thin if not negative.

In Bonds you are getting a rather good real yield of 2.5-2.8% in TIPS in the low risk spectrum and getting a rather narrow spread of 2% (before the recent sell off) in High Yield bonds on the high risk side. In Stocks you have the non-financial bluest of blue chips relatively moderately priced compared to the highly leveraged small value stocks. Basically, the low risk side of the asset classes are moderately priced but the high risk side an an asset class priced for an unprecedented new era of economic stability.

At least I am getting my prayers answered finally: Lord, I do not ask for a bull market and I do not even ask for a bear market. All I want is a little bit of volatility.

Vinod