After years of lackluster stock-market returns—which many dubbed a "lost" decade—2011 is shaping up to be a good year for large-cap U.S. stocks. Fears of a double-dip recession have mostly subsided, the economy is expanding again, and the S&P 500 has almost doubled since its March 2009 low. Individual investors are even warming up to U.S. stock funds, after shunning them in the years following the financial crisis. Here are six reasons large-cap U.S. stocks look like a good bet:
Positive indicators. The U.S. economy is officially expanding again, meaning it's now producing more goods and services than it was before the recession began in 2008. Historically, expansion phases have lasted for at least three years. So far, fourth-quarter earnings for S&P 500 companies have been robust. If this pace continues, S&P 500 companies could report record-high earnings in the second half of the year, according to Howard Silverblatt, senior index analyst at Standard & Poor's. What's more, he says, the S&P 500 is currently trading at 14 times earnings. While stocks have rapidly recovered from their lows, Silverblatt notes that the index is still about 15 percent off its all-time high.
"[The U.S. is] the primary beneficiary of an expanding global economy," says Douglas Coté, senior market strategist at ING Investment Management. "The U.S., with its developed economy, infrastructure, and businesses, is gaining the most from this global expansion." The International Monetary Fund recently upped its world economic growth forecast for 2011 to 4.25 percent, from 4 percent late last year. Emerging nations like China and India are projected to lead global growth at 9.6 and 8.4 percent, respectively, while the United States is expected to grow at a rate of 3 percent. An increasing amount of S&P 500 companies' profits are coming from the growing consumer class in these emerging markets. That's a big reason why Coté expects the S&P 500 to reach 1,450 in 2011.
Investors are making a natural transition. From the beginning of 2008 through the end of 2010, investors poured about $650 billion into bond funds while pulling almost $280 billion from U.S. stock funds, according to the Investment Company Institute. The tide has turned in 2011. For the week ending January 12, U.S. stock funds saw inflows for the first week since April 2010. Since then, domestic stock funds have seen steady inflows. "As investors take money out of fixed-income, they are more inclined to go into U.S. large-caps because many of them offer very solid dividends, and they've got very strong balance sheets, and many of them are going to be beneficiaries of global growth," says Quincy Krosby, chief market strategist for Prudential Financial.
Emerging markets outflows. Since around the time the riots began in Egypt late last month, investors have fled emerging markets funds. Emerging market stock funds posted their third straight week of outflows in early February, the category's worst three-week run in three years, according to EPFR Global. "I think what we're going to start to see [is] some money moving away from emerging markets and possibly back towards U.S. equities, and I think some of that money, at least, will have a bias toward bigger companies," says Liz Ann Sonders, chief investment strategist at Charles Schwab.
Concerns about rising food prices. Food prices make up a much larger percentage of consumer spending in poorer countries than in the developed world. Sonders says citizens in countries in emerging Asia and Latin America spend a much larger percentage of their total income on food consumption—28 percent and 27 percent, respectively. In North America, consumers spend closer to 10 percent of their total income on food. When inflation becomes a concern, central banks generally raise interest rates to slow demand. That's what leaders have done in India, Brazil, and China, the latter of which raised interest rates in early February for the third time in five months. "That's a difficult environment for stock markets," Sonders says.
Volatility has returned. So far this year, the S&P 500 is up about 5 percent. The average emerging markets stock fund, by contrast, is down about 4 percent, according to Morningstar. "What you're seeing is investors reallocating—taking from where they've done very well, and then reallocating their portfolios," Krosby says.
Until recently, emerging markets stocks have crushed U.S. large-cap stocks. From Dec. 31, 2001, through the end of 2010, the MSCI BRIC Index, which tracks the returns of markets in Brazil, Russia, India, and China, delivered an annualized 10-year return of 18 percent, compared with a 1.4 percent annualized return for the S&P 500, according to Factset. That trend is reversing itself somewhat as new risks like inflation and unrest have emerged as challenges for governments in the region. "Volatility is not dead in the emerging markets," Coté says.
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Europe's sovereign debt problems. Outside of U.S. stocks, one of the best-performing asset classes this year has been European stocks. On average, European stock funds are also up almost 5 percent year-to-date. For now, investors seemed to have shrugged off concerns about debt-ridden countries like Ireland and Greece that have recently taken bailouts to tackle crippling budget deficits. Krobsy notes that the German economy has also benefited from higher global growth because many companies in that country rely on exports. Germany's Dax Index is up almost 7 percent year-to-date.
But experts say the debt problems in Europe have only taken a backseat for the short term. European Union countries will have to decide what to do about the struggling countries. "The European sovereign debt crisis isn't going away any time soon," Sonders says.
Corrected 2/17/2011: A previous version of this story incorrectly stated the date of the S&P 500 low. It was in March 2009.