Hi. I'm Joan Solotar, Senior Managing Director of External Relations and Strategy at Blackstone. Thanks for joining us today for the Blackstone webcast, Warmer Weather and a Better Economy Are Ahead, featuring Byron Ween, Vice Chairman, Black Stone Advisory Partners. Following Byron's formal comments, there'll be an opportunity for you to ask questions. If you look at the lower left hand corner of your screen, you'll see a Q and A box.
Feel free to click on that at any point to submit your questions at any time during the webcast. At the bottom of the console, you'll see a series of widgets. This interactive feature allows you to access additional functions by scrolling over them, such as Twitter, Wikipedia, download slides and refer a friend. We plan to keep the webcast to 60 minutes, including Q and A. At the end of the PowerPoint, you'll see a full list of disclosures.
Thanks for joining us. And with that, I'll turn it over to Byron Ween.
Thanks, Joan. So it's warmer weather and a better economy ahead. We've had a kind of tough Q1, and I think the rest of the year is going to be quite a lot better, certainly for the United States, very likely for Europe. And Asia is a different story, but we'll get into that. Let's first do a brief review of the 10 surprises that I announced at the webinar in January.
Probably many of you were on that, and let's see how we're doing. We're not going to spend a lot of time on this, but I think we should spend some. I said the market would be would enter the year with difficulty, and it did. It was down 6%. I have it down 10%.
But I'm not sure we've seen all the corrective action that we're going to see in the market. I'm not backing away, however, from my belief that the market for the year, the S and P 500, will be up 20% for the year. We'll see whether the market responds to a better GDP and better earnings ahead. The second one is that the economy does better. Now I know the Q1 is going to be 2% or less real GDP, but I think the remaining quarters could work their way toward 3%, maybe even go a little above 3%.
And that's a more positive view than I think many have. The third one is that I think the dollar will strengthen. There's been no sign of that. The Fed continues to ease. It's tapering.
But remember, dollars 55,000,000,000 a month is still quite a lot of monetary accommodation, whereas the European Central Bank is much tougher and tighter. So at any rate, I do think that before the end of the year, with the economy stronger, you're going to see a better dollar. You'll see it at $1.25 a long way from where it is against the euro and you'll see the yen at $1.20 I'm a little uneasy about this one, but again, I still believe we're going to be see a much stronger dollar before year end. As far as Japan is concerned, I thought it was near term okay and longer term in trouble. It's run into trouble in the first half.
We all know the aging population problem in Japan. I think that that's ultimately going to create a diminishing workforce. The market may be anticipating that sooner than I thought. Japan is still engaged in a vigorous, stimulative program, both fiscal and monetary policy, I still think there's another leg up in the market. In China, I definitely think China is slowing.
The question is, will they reveal that? They're committed to growth at around 7.5%, certainly above 7%. But the figures that are coming out of China, particularly on exports indicate that the growth could be slower. The key challenge for China for the 2 new leaders, and it was reiterated in the 3rd plenum in November, is to rebalance the economy, to enable the consumer to become a more dominant part of the economy. I'll go into this in the China section later, but that's their objective and they can't do that without slowing the economy down.
I have it at 6%. We'll see whether they head in that direction. As far as the emerging markets are concerned, they are continuing to be difficult. I've got Mexico and South Korea as 2 I like. And I think they're going to do better.
The price of oil, in my opinion, is going to go up, not down. It has gone up somewhat, but it's around 100 now. I think we'll see it 110. The production out of the back end will continue to be strong, but other parts of the world are reducing production. Commodities, I'm bullish on agricultural commodities, and they have definitely risen.
They're not on my targets yet, but their corn, wheat and soybeans are definitely have definitely moved up since the beginning of the year. On the 9th one, I think that interest rates are going to go up. They've gone down so far. But if I'm right and the economy grows at 3%, and the Fed keeps tapering, I do think we'll see a higher 10 year treasury. And finally, I think the Affordable Care Act is doing better.
Whether it's doing well enough for the Democrats to do better in November is conjectural. Right now, that one doesn't look too good, but I definitely think the Affordable Care Act will not be viewed as the calamity that it was last October. On the also RANs, Chris Christie has definitely faded in popularity, but Ted Cruz hasn't risen. Bitcoins are not the favorite that they were at year end. We definitely are talking more about recognizing Cuba, but I think we have to wait for both Castros to die for that to happen.
And I have no idea whether Hillary is contemplating pulling out of being the 1st woman President of the United States is probably overwhelming. On my radical asset allocation, I think this is doing pretty well in a difficult market and I'm making a lot of progress, but making some 10% in high quality multinationals, 10% in other U. S. Stocks, the high quality multinationals are global, 10% in emerging markets. They're such an important part of world GDP.
You've got to be represented 10% in 5% in Japan and 10% in other Europe. So 45% long only, 30% in alternatives, 10% in hedge funds, 10% in private equity, 10% in real estate, total of 75%, 5% in gold, which has done quite well this year, 5% in agricultural commodities, in natural resources, and finally, 15% in fixed income, but at the very risky end of fixed income, almost equity like, mortgages, leverage loans, mezzanine financing and some emerging market debt. This portfolio, as I've said every time I've talked about it, is more you've got to face up to the fact that it's going to be less liquid and more volatile than the traditional sixty-forty portfolios. But I think the returns will justify that. I also said that there's no portfolio in the world that looks exactly like this, but I've been talking about it for 2 years and a number of pension funds and sovereign wealth funds have moved in this direction.
So I don't expect you to embrace it totally, but maybe there's some ideas here that will stimulate your own thinking. Why was I cautious on the market at the beginning of the year? Because everybody loved it. Everybody, no matter how you were invested, made money in the U. S.
Market last year when it was up 32.4%, up 16% the previous year. You had a general mood of euphoria in the market. The market is always vulnerable. You don't know what the reason is going to be to push it down. The market did correct.
It's now rallied back. We now have very positive sentiment once again, and that's why the market is showing a little bit of erratic behavior. So I think the market will do well overall, but we may have to have a further correction before that happens. In the midterm election, every year, the market always has a swoon. It always suffers at some point, but then the next 12 months are good.
So even if we do have a correction between now and the 4th July, I think the market will rally after that. This chart, which you've seen before, shows the contrasting policy of the European Central Bank and the Fed. Since the subprime crisis of 2,008, both the Fed and the European Central Bank have basically been in an expansionary mode. The Fed really has been pretty consistent in expanding the monetary policy. The European Central Bank was very vigorous, even more so than the Fed during the Italy and Spain crisis of 2010, 2011.
And then when those loans were paid back, the European Central Bank balance sheet contracted. And that's one of the reasons the euro is strong against the dollar. I think there's a good chance the European Central Bank will be more accommodative this year, and we know the Fed is going to be less expansionary. So that's one of the reasons why I think the dollar will strengthen. But it hasn't happened yet, but that's something to watch out for.
I want to be clear, the Fed doing $55,000,000,000 of buying of bonds, mortgage banks and treasuries a month is still expansionary. It isn't tightening. Tightening is a long way off, no matter what Janet Yellen has said in her last meeting before Congress. Let's take a look at the U. S.
Economy. The weather certainly has something to do with it, and this shows the propensity of the press to be preoccupied with the weather. More stories about the weather than going back more than 20 years. So the weather has been a preoccupation. I said in the rehearsal for this that we've seen our last snowfall.
Let's see whether that turns out to be right. Why did Bernanke in his very last meeting when he was about to hand the baton to Janet Yellen, why did he announce the tapering? He felt guilty that the Federal Reserve was a buyer of last resort for treasuries. When the Federal Reserve balance sheet was 1,000,000,000,000 dollars in 2,008, treasury securities on the balance sheet were only $97,000,000,000 less than 10% of the Fed balance sheet of $1,000,000,000,000 a balance sheet that had only reached $1,000,000,000,000 in the 95 years that the Fed had been in existence. In the next six years from 2,008 to now, the Federal Reserve balance sheet is approaching $4,000,000,000,000 4 times the size in 2,008 And treasury securities are close to $1,000,000,000,000 of it or 25%.
So Bernanke was feeling, look, this has got to stop. We are playing too dominant a role in the treasury market. And so that's why he announced the tapering process. And that's why it's continued during John Yellen's early term. I'm optimistic that the economy is going to pick up steam.
The Economic Cycle Research Institute has been the best forecaster I've found in terms of determining the course of the U. S. Economy. It accurately predicted the second half slowdowns of 2010, 'eleven and 'twelve. It didn't predict 1 the last year and we didn't have 1.
And it's not predicting 1 this year. So I think for all kinds of reasons, some of which I'm about to show you, the economy is going to pick up from now on. One of the biggest problems we have is that here median family income has not increased. We've been in a recovery since June of 2009. Corporate profits have improved enormously.
Household income has improved, but median family income has been flat. So the average family has not benefited from this recovery. We can see that in food stamps. We during Katrina, we had 15,000,000 people on food stamps. We have 45,000,000 people on food stamps today.
A large segment of the American population is suffering. Now here we have a couple of contrasting signs. The purchasing manager survey of manufacturers showed a sharp downturn. There are other surveys that children manufacturing is doing better. And that's in contrast to heavy truck orders, and they are very strong.
So these are 2 contrasting things. I think you're going to see a recovery in manufacturing from now on as the weather warms. And I think heavy truck orders are presaging a stronger GDP. In terms of oil, I think we're moving towards self sufficiency, but we may not get there as soon as everybody thinks. Worldwide demand for oil, as determined by worldwide GDP growth, is moving ahead faster than worldwide production.
And you see a sharp increase in production accidents in transportation. We've read about rail accidents coming out of North Dakota. So I think the environmentalists may have more influence over North American production than the average observer is projecting. Nevertheless, I think we're going to move towards self sufficiency. We just may not get there as soon as everybody thinks.
The increased or incremental demand for oil is coming from the emerging markets. If you look at the right hand chart here, a table here, you can see Brazil is only using 5 barrels of oil per person per year. China, 3. India, less than 2. And there's no way these developing countries are going to consume oil at that low rate.
The United States, perhaps we're more profligate, the United States is consuming 21 barrels of oil per person per year. And I don't think the emerging markets are going to get anywhere close to that, but they could be between 5 10 over the next few years. And remember, there are 2,500,000,000 people in China. So if they increase their consumption in China and India, if they increase their production their consumption to something like 4 barrels of oil or 3 barrels of oil, that's an awful lot of pressure on the worldwide producers. This shows that profit margins are at an all time high, but unit labor costs have been flat during the recovery.
So another way to express this is that corporations have benefited in terms of profitability at the expense of labor. One of the ways they've done that is they've used technology to get the goods and services out the door with fewer workers. They bought capital equipment that enables them to increase production without hiring laid off workers. That's been a unique characteristic of this cycle. Corporations began the cycle with a lot of cash on their balance sheet and they used it to buy labor saving devices.
That had never happened before. In the previous recoveries, corporations had used the cash on their balance sheet to hire laid off workers. But this time, they used it to buy equipment and that's why unit labor costs have been flat and it's been a big boost to profitability. As a result, we still have a structural unemployment problem in the United States. Ordinarily, as I've said before, in a recession, the unemployment rate would be 10%, in the recovery, it would be 5% and here we are almost 5 years into the recovery.
It was a 10% but it's 6%, 7% now. So we structural problems are caused by technology, which has replaced workers and globalization. Those two factors have created a structural problem in the United States, which we haven't addressed. We should have addressed it in a variety of ways beginning in 1980 when it first appeared, but we haven't done that. As a result, you can see that even though we've drawn down U6, this is the number of workers employed part time who would like a full time job, even though that's down from the peak, it's still higher than the previous peak underlying the structural problems that we have in employment.
The weather has really affected the forecasters. They have really they moved down their estimates for the Q1, I think too much so. And they've also adjusted their full year forecast. But I think they're moving up. Right now, we're about 2% for the year, and I think they're too low.
I think for the full year, we'll be much closer to 3%. Consumer sentiment has improved, but it's nowhere near where it was before the subprime crisis hit in 2,008. And the right hand chart, which shows household net worth is at a more all time high. But the problem with that is that it's really benefited those at the higher end of the income stream. Those people own stocks.
They have second homes, they live in more expensive primary residences and that's the part of the real estate market that's appreciated. And of course, the stock market has gone from 666 on the S and P 500 to above 1800. So the top 20% of the economy has really benefited clearly in the top 10%, 5% and 1% even more so, but the bottom 20% has stagnated and I'm going to show that in a different way at the end of the presentation when I talk about inequality. But the point is it's been a very uneven recovery benefiting those at the higher end more than those in the middle and lower end. And that's why there's so much focus on the inequality problem.
We could employ more people if we were to build more plants, but capacity utilization is still below 80%, and so there's no impetus on the part of corporations to build more plants. There's still plenty of slack capacity out there. This shows one of the reasons or 2 of the reasons that I'm encouraged. Bank loans, if you look here, have taken a sharp move up. Now why are companies borrowing?
They're borrowing because they've got a higher degree of confidence. They're willing to add the inventories, and maybe they're willing to at least plan to spend more money on capital equipment. And railcar loadings. And this ships not only agricultural products, but also manufactured products. And that's in an uptrend.
So these two indicators give me some support from my view that the economy is going to pick up above the 2% real GDP rate and move toward 3%. This shows whether you should be concerned about inflation and higher interest rates. Right now, this is a focus on nominal growth rates. Most people talk more about real growth rates. But nominal growth in the United States right now is about 3%, roughly 1% inflation, 2% real growth.
But I think it's going to move up to 4% or 5%, 3% real growth and 1% to 2% inflation. Now if it does move up to 4% to 5% real nominal growth, then you could see the 10 year treasury move up toward 4%. If the nominal growth stays near 3%, I think the treasuries will stay between 23. But if nominal growth goes to 5, I think you'll see the 10 year treasury move toward 4. So that so you should watch 2 things, real growth and inflation.
I don't think inflation is going to be a problem. As I've said before, inflation is largely a function of wage rates and house prices. And while house prices are moving up, they're not moving up sharply. And wage rates aren't moving up much at all. So I think inflation is going to be tame, but it's going to be a little bit higher than we've experienced so far.
So I do think that we're not going to have a 2% percent treasury forever. I think it's going to move toward 4%. But I think you're going to see signs of that before the end of the year. Let's take a look at the market and earnings. The 4th quarter is expected to be much slower than the earlier quarters during the year.
And this is, again, people preoccupied with the weather. If you look at estimates, though, estimates are creeping up for the Q4. So my feeling is that once the earnings are in, people are going to feel better about the full year earnings outlook. One of the things to focus on is revenues. Revenues have been estimated at lower levels as a result of the cold winter, but I think that's going to reverse.
This shows to be that you should be wary of analyst estimates. The black line is what earnings are actually reported at. The blue line is the forecast. And you see that earnings rarely come in at the level that they've been projected at. That analysts tend to be too optimistic.
And there's some reason to think that that's underway now. What you see here are the earnings expectations. They've been drawn down because of the cold winter weather. I do think as the weather warms, analysts will become more optimistic. Right now, earnings are only increasing at about a 4% rate.
But right now, earnings are going to come in at about $108 for 20.13 and they're projected at $115 for 20.14. So they're going to go up more than the 4% rate, more like 7%. And I think that that is likely to be hit. One way for you to follow it is with this table. On the left hand side, there are levels for profit margins.
We're assuming in the shaded blue area that profit margins stay at their present level. The blue vertical line shows various revenue levels and the blue shaded is approaching a 5% revenue increase. Now right now, revenues are only increasing at about 4%. So in order to hit the 115 that analysts are using, you have to keep margins where they are and you have to have revenues approach 5%. So those are the 2 variables to keep an eye on.
As I said, revenues currently aren't running close to 5%. So I have to be right about the economy improving and revenues for corporations improving along with it. You can see here that profit margins are stable at the present levels. The suspicion is that they're peaking. I think they're likely to stay where they are.
And this chart is probably the most powerful one. It shows that in spite of the fact that the S and P 500 was up 16% in 2012 and 32.4% in 2014, it's not overvalued. It's just a little bit above the median price earnings ratio. It can easily sell at 20 times. If it's sold at 20 times 115, that'd be 2,300 on the S and P.
And I think that my optimism for this year's performance would be vindicated. Corporate profits have not been as good as earnings per share projections. And I think that's something to keep in mind. But corporations have increased earnings per share by through share buybacks. Share buybacks have been very strong.
They're running at $350,000,000,000 annual rate on a market that's valued at about $16,000,000,000,000 So share buybacks have been largely accountable the earnings per share improvement. In terms of our fiscal dilemma, we've really made improvements. There'll be talk about tax increases, but no matter what the taxes are, they rarely come in above 15% to 20% of GDP, whether they're 50% or 70% or 20%. They still tend to hover around 15% to 20% of GDP. When they're higher, people look at ways to work around them.
We have made dramatic improvements in our budget deficit circumstance since 2010. In 2010, the budget deficit was 10% of gross domestic product. Today, as I'll show you in the next slide, it's 3%. Why? Because we've improved our revenues through tax increases and we've reduced expenses primarily in defense and in entitlements.
So these two things have contributed to the fact that the budget deficit today is only running at 3% of gross domestic product, a truly dramatic improvement. And what's more, it gives us some room to do some spending on things like infrastructure, job training and research and development, which would improve our long term growth prospects. But there is no appetite in Congress to do that. This shows that lobbying is directly proportional to GDP growth. It's amazing how much we spend in this country about $150,000,000,000 on lobbying expenses.
We're spending a little less now than we were because the economy is slower and there's not much action in Congress. But lobbying is a big business, and it's a big drain on the economy. Switching over to Europe, good news there. Europe came out of the recession the same way we did. It had a surge after 2,009, but then slipped back into recession.
But I'm happy to say that the 4th quarter was up over 1%. I think Europe will have about 1% growth throughout this year. You can see that in terms of the analyst projections. So I think Europe is going to have a better tone to it And there's some very attractive valuations in Europe. And that's why I've got 10% of the radical asset allocation in Europe.
Eurozone Manufacturing PMI is definitely improving and Europe, even though it's a high cost producer, has plenty of demand for its exports. The big problem in Europe is unemployment. It has 12% overall unemployment versus R67 And youth unemployment in Europe is 25%. So they have structural problems just as we do. Turning to commodities for just a moment.
You can see here, I was bullish on commodities in the 10 surprises. And here you see a sharp increase in commodity prices during the Q1 of this year. Turning to the emerging markets in China. You can see that the price earnings ratio for the emerging markets has gone nowhere, whereas the price earnings ratio for the developed world has increased. And the cumulative performance of the emerging markets, as those of us who have been exposed to them painfully know, has been very lackluster, whereas the developed markets have done quite well.
So that means that there are pockets of opportunity in the emerging markets. Most people don't want to touch them. That was the same condition in commodities. Nobody wanted to have a commodity exposure in their portfolio and that's one of the reasons commodities have rallied and nobody wants to own emerging markets. I just came back from a week in Latin America and Chile and Colombia.
Nobody no overseas investor is interested in those markets and that's why there are opportunities there. Every portfolio should have some exposure to emerging markets in my opinion. You have to be selective. It isn't across the board, and it probably isn't in India and China right now or Brazil, but there are emerging market opportunities. As I said, Mexico and South Korea attract me.
In terms of China, they are still claiming they're going to grow better than 7 percent, but I'm concerned about that because they are still so dependent on borrowing to grow at that 7% area. You can see expanding loans is year over year rate is near 20%, and that's how they're showing the growth and they want to be less dependent on investment spending and that's the commitment. You see here in this chart that investment related spending on state owned enterprises and infrastructure is 45% of GDP. The consumer is 35%. They said in 2010, in the 5 year plan that was announced that year that they were going to reduce the investment spending to 35% increase the consumer to 45%.
But according to my analysis, there's no way they can do that and still grow at 7.5%. So I think the growth is trending towards 6%. Whether they have the political resolve to report a number like that is something else again. But keep an eye on it because I think the demand in China is diminishing. And I think the export that's shown up in exports.
And so I think that you're going to see China struggling to grow at better than 7%. I don't view that as bad news. I think the rebalancing is necessary for the long term healthy growth of China, but we'll see whether it materializes in 2014. In Japan, they definitely are growing. Growth has resumed there.
I think they're going to have growth between 1% 2%. I think that inflation won't reach the 2% objective that Shinzo Abe wants. I think that the growth will be consistent above 1%. And I do think that the yen will depreciate further definitely to 110, maybe to 120 and the Japanese government debt will continue to increase. And I do think we have another leg up on the Nikkei-two twenty five.
Okay. Now on the inequality issue, it's on everybody's mind, particularly President Obama, who says it's the key challenge that we're facing our generation is facing. There's no question that in the recovery since 2,009, the top 10% of the economy of the income earners have benefited. They own most they have the largest ownership of stock. They have the largest ownership of real estate, of second homes.
And so the top part of wage owners have definitely been beneficiaries. The Brookings Institution has analyzed what they call the 90fivetwenty ratio. That's the income of those in the 95th percentile versus those in the bottom 20th percentile. And what you see here is that the 95.20 ratio is about 9 for the whole country, but there are a number of cities where it's 15, meaning that the 95th percentile is 15 times the 20th percentile. So there is no question in my mind that there is an inequality issue.
But I don't think it's because the wealthy are exploiting the workers. I think that what we've got to do is focus on more opportunity for the bottom 20% because the top 20% don't or the top 5% are just pursuing their dreams. They're trying to do as well as possible, but they're not trying to deprive others of opportunity. If you look at it, education is often thought of as one of the reasons for it, but we're not doing as well in education as we should be based on the amount we're spending. We're 17th in reading, 20 this is the PISA OECD study, were 21st in science and 26th in mathematics.
Students in the United States just don't have the skills and quantitative skills to cope with real world problems. And that's one of our biggest competitive potential competitive disadvantages. And the people often apologize for this by saying, well, maybe the average student isn't all that great, but our top students are terrific, but the data don't even support that. In math, our top students are 9th, better than the OECD average, but nothing like what the Asian students are able to deliver. And not only that, but you've got to look at some of we're spending more on education than almost everybody else.
Per capita income in the United States is greater than any country but Switzerland or Luxembourg. We spend more on education than Switzerland, Luxembourg, or Norway. We have the most educated population, so you would think our kids would do better than school. In school and our share of disadvantaged kids is no greater than in other countries. Look here on this chart, the Slovak Republic spends $53,000 per student per year and has test scores that are similar to ours at 115.
And in Korea, which spends about the average, has the highest performance in mathematics. And students in the United States are more likely to skip a day of school in a 2 week period. But kids who have had preschool, pre kindergarten education tend to do better. This shows a truly dramatic change in American society during the last 34 years. In the year 1980, the number of kids born to unmarried women was only 18% of total births.
18% of total births were to unmarried mothers. In the last 34 years, that number has more than doubled. Now 41% of kids are born to unmarried mothers. So if you think of an unmarried woman trying to raise 1 or more kids, hold a job, keep the household up, I think it's a tough job. So I think that that's one of the problems that we're facing in the U.
S. The head of the American Enterprise Institute has said that this is a social problem. We have to really strengthen our communities and restore American values of faith, family, community and work. But I think changing society is a very long term process. So there's no question we've got an inequality problem.
We've got to focus on it. There's more attention being paid to it. Education is a part of it, but values are a part of it as well. Okay, that covers the formal comments I wanted to make during the presentation. I thought I would touch on the inequality issue because it seems to be on everyone's mind.
I wish I had a solution to it, but I do believe that more focus on it is likely to bring us closer to improving the situation, if not solving it. Okay, now we're at the question and answer period. And I want to turn the session back to Joan Solitar.
Great. Thanks, Byron. And just a reminder, if you do have a question to hit the button on your screen, but I'll start with what we have. In the past, you've talked about corporate margins peaking and you're showing commodity price is rising. I mean, is it but now you're saying essentially you think margins can be sustained.
Do you think that we're going to see passing through of higher commodity prices? Or how does that unfold?
Well, first of all, there's a certain amount of leverage in increasing revenues from 4%, which is they're running less than 4% now, to 5%. So I think that some of the increase in commodity prices is going to be absorbed by increased revenues and the leverage that we'll derive from that. But the other part of it is this, that I think that there will be some price increases. I said that I thought inflation would move from the 1% to 2% level. So I think you will see some price improvement, but not dramatically so.
I don't think we'll be in an inflationary environment. I think the real reason that commodity prices will be offset is because of the leverage from increased revenues. But also commodities are not as big a part of corporate expenses as everybody said. I wrote an essay during the past year, which pointed out that increase that everybody was enthusiastic that America was going to have a manufacturing renaissance because of lower oil prices. Well, first of all, I don't believe that oil prices will be lower.
But even if that were true, the energy component of manufacturing is very small in almost all the 10 S and P 500 categories. Only in the chemical industry and in agriculture is energy a big component. In every other case, it's less than 10%. So revenues are part of the reason. I'm not afraid that margins will be squeezed.
And I don't think that commodity prices will put that much pressure on margins.
And is it your sense that company is going to be buying back less of their own stock because of the growth prospects, they'll now start to invest more in manufacturing and expanding?
I think that will be some of it. But there's still, for most corporations, buying your own stock back is the best way to increase earnings per share and the return to shareholders. That was true in the last 2 years. I still think it will be true this year, but perhaps to a lesser degree than in 2013.
Okay. You highlighted that in the U. S. Price to earnings ratios are modestly above the mean or the median right now. And oftentimes in hindsight you can say, well, the PE was actually higher or lower because estimates were wrong.
But based on your assumption that estimates are going to start to move up or continue to move up, would you say that there's actually more value in the U. S. Market that even that 16 multiple is probably too high based on real earnings?
No, I don't think I think the 16 multiple is a bargain at these interest rates. I used to have a model which I thought was going to carry me through to retirement, which related the price earnings ratio for the S and P 500 to the 10 year treasury yield. And for the 1st 20 years of my career, it served me very well. I was able to forecast the market based on 10 year treasury yields. Then in the 1990s, it broke down and I had to abandon it.
I still keep it in a desk drawer and look at it once in a while, but it would argue that the market should be 2,300 today at these interest rates. No, my feeling is that if I'm right and interest rates stay below 4% and earnings improve to the 115 level, that buying the market at 16 times earnings is a bargain.
Okay. And taking that to some of the overseas markets, you would think with faster growing markets that the multiples might be higher. But as you show, there's just a huge gap between U. S. And emerging markets.
What accounts for that?
I think there are a lot of factors. People are very nervous. The best way for the emerging markets to do well is if the indigenous people invest in those markets. When the indigenous people are pulling the money out of the market, that's not a good sign. That's why all the emerging markets suffered when Ukraine got into trouble.
The oligarchs were pulling their money out, so even if you were in Vietnam, you began to get a little nervous that maybe there was as much political stability as you would like. I think that I think most emerging markets are pretty stable. Certainly the ones in Latin America, I think are. I think the ones in South Asia are. I think China is stable.
I think India is going to improve politically. But people are still very nervous. The emerging markets are growing twice as fast as Europe and the United States, and there are very attractive values there. But for people to get interested in it, they have to believe that the countries are politically stable. And the best way to see that is when the people who are living in those countries, who are accumulating wealth in those countries are reinvesting in those countries.
So if you think about your asset allocation model, where the last time you adjusted, you actually adjusted emerging markets down from 15% to 10%. Are you moving closer now to thinking that could be higher?
Well, I'm pretty comfortable with the 10%. I think I underestimated the migration of capital out of those markets, and that's why I reduced the percentage. I have to face up to reality, I have to invest in the way for the way things are rather than the way I think they should be. So that's why I reduced it and I'm pretty comfortable with the 10% right now.
Okay. Shifting over to fixed income markets, when you look at just even the bank loan growth, it's pretty dramatic. There's been pretty good access to public markets, credit, etcetera. Is it your sense that credit is generally overbought right now and that there's too much availability of cheap capital?
Well, this is a complicated issue. I think credit I definitely think I've gone around the world and encouraged every sovereign wealth fund to sell their U. S. Treasuries. I often wonder whether my passport will be recognized when I get back in the country.
But anyway, I don't think there's good value in treasuries. I don't think there's good value in high quality corporates. I don't even think there's good value in traditional junk bonds. I think you have to move to the riskier end of the fixed income scale, mortgages, leverage loans, mezzanine financing and emerging market debt in order to get good value. That's where the values are.
But those are equity like, they're not bond like. And that's why I characterize the radical asset allocation as an all equity portfolio. But I think we're going to see growth around the world in the United States. And I'm not afraid to have a strong equity orientation in my asset allocation.
One region we really didn't touch on very much is Europe. Can you just give us your assessment today of where we are? Is Europe 12 to 18 months behind the U. S. At this point?
Europe is definitely doing better. I mean, they are out of the recession. They have absorbed some of the credit problems that they faced in Italy and Spain and Greece and Portugal as well. I mean, 2 years ago, Joan, we were talking about whether the European Union would survive and whether the euro would be the currency. Nobody talks about that anymore.
We're perfectly comfortable that the euro is here to stay and the European Union is here to stay. But on the other hand, I'm very disappointed in Europe because they haven't made the structural problems they need to make to sustain the union on a long term basis. They've got to do that. Now they're moving closer to a banking unit, which I was very critical a year ago in talking about because they weren't making progress on that, but now they are. They know what they've got to do, but they haven't been willing to give up enough of their sovereignty to make the European Union converge on a fiscal basis.
They'll never converge on a political basis, I realize that. They're always going to be independent sovereign countries, but they could have more fiscal harmony. They could submit their budgets to the European Commission and be punished if they run deficits greater. They seem to have a greater sense of that. Maybe Ukraine, maybe facing up to not supporting Ukraine as a trade partner in the European Union, maybe that's a shock of recognition for them.
I think Europe is getting better, but it's got to get better yet for the long term sustainability of the European Union.
So we have a question on M and A, I don't know if you have a view on this but the question is whether we'll see a pickup in activity?
I definitely think I think American business is coming around to the fact that there are corporations that can be acquired strategically, advantageously. I'm not saying I think financial deals are going to be harder to do, which has some implications for us. Just buying a company because you think you can improve it, I think that's going to be harder to do. But if you can buy a company, absorb it into your infrastructure, cut expenses that way and augment your marketing with their products, I think a strategic you're going to see a lot of strategic acquisitions. I think you will see relatively few acquisitions just because they're undervalued companies that can be bought, leveraged up and profit and the buyer can profit from a financial transaction that's been primarily financially based rather than strategically based.
And can we move over to Japan where you have 5% allocation? It seems like you're pretty optimistic that they're doing all the right things, should not be worried about budget deficits, etcetera. Just give us your view, are you expecting some volatility corrections? How should we be thinking about
Well, look, it already has corrected. So what I'm saying basically is it's going to do better from here. There are a lot of cheap stocks in Japan. And there is a country that seems to be doing the right thing. But people are concerned that it is leverage dependent, that it wouldn't be where it is if it weren't running big budget deficits, the largest budget deficit to GDP ratio in the industrialized world, and if it weren't expanding the money supply vigorously.
So people are worried that Japan is living on borrowed time and I think that's why I corrected. But on the other hand, it seems to be working. Remember, Japan most of that government debt in Japan is held in Japan. They aren't dependent on the kindness of strangers the way we are. And so that's why I think that the debt dependent growth, the monetary expansionary dependent growth that Japan has is more sustainable than it would be in an alternative country.
And going back, you had some pretty provocative slides towards the end on income inequality, shifting household formations. We could probably spend hours talking about what the investment implications of those are, but perhaps even just giving us 1 or 2 highlights.
Okay. Well, look, what we need is an educated, motivated workforce. And if we have all the number of kids graduating high school stabilized at around 70% in 1970. So here we are more than 40 years later, and we still have 70% of the kids graduating high school. You don't have a high school education, you have a tough situation looking forward.
So I think we've got to improve the graduation rates and we've got to improve the skill level. That's why I had that section on education. I think family formations are important. We've got to encourage people to raise kids in 2 parent families. I think that that's important because otherwise the time spent by a single mom or a single dad raising a kid, there's just too much to do to provide the guidance during the critical teenage years.
So I think we have to look at family values and do what we can to encourage an improvement there. I think we have to look hard at education and try to get more out of the money we're spending. We're spending enough money. That was one of the points I tried to make. We're spending enough money, but we're not getting enough bang for the buck.
We've got to make a better use of charter schools, better use of things like Harlem Children's Zone, KIPP Academy, Seed Foundation. There are a whole slew of wonderful things going on in this country that can be a model for other schools throughout the nation. We've just got to take advantage of that. One of the reasons I covered the inequality issue is it's one of the challenges facing America. And if America is going to continue to be a leadership nation, we've got to face up to the inequality problem.
And the way to do it is to focus on the bottom, not say that people are doing something wrong at the top. I think Paul Krugman has it wrong. The people at the top are probably not doing anything wrong and they're probably a part of the solution because most of them are pretty philanthropic. It's improving the situation at the bottom that we have to focus on.
That's interesting. And then final question, as you think about your asset allocation today and as we move through the year, is there anything that you'd consider changing?
Well, parts of the Japan part isn't working, the emerging market part isn't really working, but the other parts are working. It is an asset allocation, it isn't a trading template, so I'm not trading it. I'm going to give it a little more time to see whether I'm in the right place there.
Great. And I do hope you're right on the weather as well, looking for warmer. Do you have any final comments?
No, but I'll do another webinar in July. And this one was a little bit early because I'm going to Asia next week for 2 weeks and I expect to learn a lot there.
Terrific. Thank you, Byron. Thanks everyone for joining us.