As in most downturns, the middle and lower classes are taking the brunt of this less-than-stellar economic environment. The current abundance of pessimism has resulted in the “Occupy Wall Street” movement, a demonstration that bemoans the fact that while banks got bailed out by the government, the working class have been left to fend for themselves.
But a funny thing happened on the way to the demonstration. Stock prices dropped, even as profitability stabilized and, in many cases, increased. Nearly 72% of the firms in the S&P 500 index profited more than consensus estimates. For the 21st quarter in a row, companies spent less money than they generated.
Meanwhile, Standard & Poor’s downgrade of U.S. debt caused a perverse flight to quality rally in the very same asset S&P sought to disparage. Bond prices rose dramatically, yields fell and, for income-oriented investors, even long-dated Treasuries can’t generate enough interest to meet their needs.
The situation in Europe is dominated by fiscal problems in Greece, Italy and Spain. There is concern that the instability of the EU could eventually lead to its demise. That, combined with the region’s unemployment issues and debt issues, has led to a remarkable divergence between emerging and domestic market sovereign debt.
According to Morningstar, the 12-month yield of intermediate U.S. government debt is 2.77%—dramatically lower than the 4.85% of emerging markets in local currencies. Similar differentials can be seen between the P/E ratios of domestic and emerging market equities. As in the above example, these gaps should eventually converge.