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Policymakers Hold the Key to Confidence
The Dow Jones Industrial Average fell 0.9% to 13,158, the S&P 500 Index slid 0.5% to 1,411 and the Nasdaq Composite lost 0.2% to close the week at 3,070. As August draws toward a close, US equities have hit four-year highs, corporate bond yields touched multi-year lows and many risk assets can look back on a pretty good summer. But despite plenty of investment and central bank activity, we continue to see a shortage of economic and financial market confidence.
What Will it Take for the Rally to Continue?
One of the factors underlying the upturn in stock prices over the past couple of months has been a modestly improving trend in US economic data. Last week, retail sales advanced 0.8%, well ahead of expectations. This was the first increase in four months, which suggests that while households remain generally cautious, spending levels are beginning to tick higher.
Stocks Look Poised for Continued Gains
Although investor attention seems focused on a number of well-known downside risks (including the European debt crisis, hesitant US economic growth and the pending US fiscal cliff), stocks have continued to climb higher and last week notched their fifth consecutive week of gains.
Looking Past Weak Data; Awaiting Policy Responses
Although last week featured some lackluster economic and earnings news, investors continued to focus their attention on the growing possibility of additional monetary policy action, particularly from Europe. For the week, the Dow Jones Industrial Average climbed 2.0% to 13,075, the S&P 500 Index advanced 1.7% to 1,385 and the Nasdaq Composite rose 1.1% to 2,958.
Markets Likely to Continue Moving Unevenly
Notwithstanding a pullback on Friday, stocks managed to post gains last week despite a generally negative tone to the economic data. In some ways, the recent trend of relatively weak data has actually been beneficial for stocks in that it has been boosting hopes for additional policy stimulus around the world. For the week, the Dow Jones Industrial Average climbed 0.4% to 12,822, the S&P 500 Index advanced 0.4% to 1,362 and the Nasdaq Composite climbed 0.6% to 2,925.
Bull Market Has Been Buffeted, but Remains Intact
During a relatively modest week in terms of trading activity, stocks managed to stage a rally on Friday that helped erase the declines of the previous four days. The stock market gains over the past month can be largely attributed to the perception that policymakers in Europe have been making some progress combatting the ongoing debt crisis. There is a sense of uncertainty over the state of the US economy, and that uncertainty is making investors, companies and consumers wary about the future.
Markets Vacillate Between Weaker Data and Hopes for Policy
Last week was a modestly negative one for stocks as investors continued to focus on a trend of weakening economic data. Additionally, many were disappointed by what was perceived to be a less-than-robust response from the Federal Reserve following its policy meeting last week.
Will Policy Response Follow Policy Rumor?
The past two weeks have been better for stocks, with the major indices up in consecutive weeks for the first time in more than a month. Europe remains stuck in a cruel cycle of recession, a banking system in need of life support, frozen policymakers, too much debt and a downward confidence spiral. In the United States, economic growth slowed this spring (likely due to poor weather and the earlier spike in gasoline prices), but remains intact.
Investors Look Forward to More Policy Help
Following a significant slide the week before, stocks bounced back last week, primarily due to a growing sense that policymakers in Europe and the United States may be ready to engage in further easing measures. The increasing stress in Europe has put additional pressure on the European Central Bank (ECB) and on other policymakers to take stronger action, and, indeed, over the weekend European finance ministers announced a new plan to recapitalize the Spanish banking sector.
Negatives Intensify, but Panic Isn't Warranted
For some time, we have been suggesting that the US economy had been holding up relatively well compared to the rest of the world. While we are not changing that view, last weeks data (particularly Mays employment report) provided a negative jolt and pushed stock prices down sharply. Our summary view of the US economy is that while the United States appears to have entered another slowdown phase with the data growing more disappointing in recent weeks, the case for a renewed recession still looks flimsy.
Beyond Short-Term Risks, Stocks Are Growing More Attractive
Given our view that the European debt crisis should remain reasonably well contained and our belief that the US recovery remains on track, our outlook for risk assets continues to be a positive one. The combination of the rising equity risk premium, falling stock prices, improving corporate arnings and lower Treasury yields means that stocks have become quite cheap relative to bonds. Assuming that the world is not headed for a renewed deflationary spiral, there is little doubt in our view that stocks are poised to provide superior long-term returns over bonds given their current levels.
Are We Near the End of the Correction?
Although US economic data was generally good last week, stocks sank sharply as investor fears over Europe's debt problems intensified. Despite the mounting crisis in the eurozone, the US economic recovery continues to look stable. While it is true that US stocks have taken a turn for the worse over the last month, other markets (particularly European stocks) have been hurt even more. In our view, markets are awaiting some sort of positive jolt (perhaps in the form of a policy response in Europe or some stronger US economic data) to break out toward the upside.
The Bull Market Has Not Yet Reached Its Highs
It has been the case for some time, but recent events serve as a reminder that the primary risk to the global economy and markets is the ongoing debt crisis in Europe. Confidence over policymakers' ability to deal with the crisis took a hit recently given that the election results in Greece and France signal a shift away from governments' willingness to move forward with unpopular austerity measures. The resulting political uncertainty and investor confusion has put downward pressure on stocks and other risk assets. Unfortunately, the reality is there is no quick fix for Europe's problems.
Despite Uncertainty, the Bull Market Should Persevere
There is a great deal of uncertainty that is acting as a headwind for the markets. In the United States, perhaps the main uncertainty is over the looming fiscal and tax issues that must be dealt with before the end of the year. Additionally, the still-developing European debt crisis has the potential to derail markets, as does the possibility for worse-than-expected economic growth. In any case, while we do expect to see markets continue to churn for the near term, we also believe that stocks will eventually be able to resume their climb.
Euro Risks Continue but Support for Risk Assets Is
At this point last year, two of the major downside risks were the possibility of the European debt crisis spiraling out of control and the inability of the United States to get its fiscal house in order. Today, while these remain two factors that have investors concerned and while there are some similarities between the situations one year ago and today, there are also some important differences. The US fiscal policy is murky. The tax and fiscal policies that are set to expire at the end of 2012 are clouded in uncertainty and it is impossible to view them outside the 2012 elections.
Global Policy Remains a Critical Catalyst
The economic backdrop continues to be mixed, but the overall trend continues to be one in which the US economy appears to be growing slowly. One interesting pattern that has emerged is that the US household sector has been picking up at the same time that the industrial side has been weakening. While an improving household sector is critical to ensuring long-term growth, there are some caveats to this trend. First, households have been dipping into their savings to boost spending, which is clearly not sustainable. Additionally, some of the growth may have been "borrowed" from summer quarter.
Market Drawdown Presents Buying Opportunities
Given the relative differences between the economy in 2011 and what it looks like today, we believe the US economy will be more resilient than it was last year. We would also look to corporate earnings as a source of strength. Although we are forecasting that the pace of earnings growth will be slower this year than it has been in the recent past, so far the data has shown that corporate earnings have been doing just fine. Expectations for the first quarter have been set relatively low, but so far over 80% of the companies that have reported have surpassed expectations, which is a good sign.
Have We Reached the End of the Rally?
Our overall view about the markets is that improvements in the global economic outlook, continued easy financial conditions and slowly improving investor risk appetites are all reasons that stock prices should continue to crawl higher. Markets have, however, paused somewhat in their rally over the last several weeks. This can be attributed to the fact that prices had risen so far so quickly and that markets were overdue for a period of consolidation or correction, but it is also important to emphasize that we will need to see further evidence of economic improvement for gains to continue.
Overcoming Objections to Equities
So what are some of the improved economic conditions that have been pushing yields higher? We have devoted quite a bit of space in recent weeks to discussing the improvements in the labor market, and while jobs growth is certainly among the most important economic indicators, there are other factors that have been showing signs of improvement as well. Debt deleveraging remains a source of concern, but we have been seeing progress on that front. Individuals have been paying down their debt over the past few years and household debt levels have been falling noticeably.
Stocks: More Room to Run
While it is important to remain cognizant of the risks facing the markets, our overall view toward stocks remains constructive. Since the current rally began last autumn, we have seen some market pullbacks, but they have been brief and shallow, likely because many investors remain underweight equities and have been using pullbacks to buy on price dips. Now that bond prices are falling, we believe investors as a whole will finally begin to move out of Treasuries and into stocks. As such, as long as the macro fundamentals remain reasonably good, we believe equities should grind higher from here.
An Overweight to Stocks Is Still Warranted
We believe the macro environment remains equity-friendly and we would argue that it still makes sense to retain overweight positions in stocks. The economic expansion should continue, inflation remains muted and central banks around the world are hyper-focused on maintaining easy monetary policy. Add to this backdrop the fact that stock valuations remain attractive, and the case for sticking with stocks gains strength.
Investors Are Skeptical, and Pace of Gains Slows
Even with the S&P setting new post-crisis highs, we don't think stocks are ahead of themselves. While we may not be pricing in a recession like we did last October, markets are in the same place as last April but earnings are up nearly 15%. The October market bottom also seemed to have technical characteristics of an important low. While there remain plenty of problems, including rising oil prices and profit margins at very high levels, we recommend overweighting equities. For investors that are underweight equities, we recommend continuing to dollar-cost-average to increase exposure.
Equity Gains Likely to Continue, But at a Slower Pace
It was a relatively subdued week in terms of economic data, with the highlight perhaps being the weekly initial unemployment claims, which were unchanged (a stronger-than-expected result). This data helps confirm that improvements in the labor market have been gaining traction. This Friday we will see the February employment report and most economists are calling for a new jobs number of 200,000 or higher with a flat or perhaps slightly lower unemployment rate.
The Macroeconomic Backdrop Continues to Improve
Looking ahead, we believe the backdrop for risk assets remains a solid one. The global economy is hardly experiencing boom conditions and remains subject to the hangover effects of the financial crisis, but improvements have been real and sustainable. Interest rates around the world are low. This backdrop, combined with at-least reasonable valuations, should help equities to continue to outperform. On a near-term basis, the improvements we have seen in recent months do appear to have been absorbed by the markets, which explains the recent nearly uninterrupted move higher in stock prices.
The 'Risk On' Trade Remains the Right Call
The risk on trade is the right one in the long term given that the worlds major economies are healing and that debt problems are slowly improving. These processes will not occur in a straight line and we will see setbacks along the way. The rise in risk asset prices, however, has been in a more-or-less straight line, with US stocks rising close to 25% over the past four months. As a result, at some point we will almost certainly see at least a pause in the upward move as markets experience some sort of consolidation or corrective action.
Markets Continue Their Winning Ways
Notwithstanding the strong performance of the last month, we believe markets are still pricing in a more negative economic backdrop than what we are predicting. Investor confidence remains low and many are still sitting on large amounts of cash. It is important to remember that stock prices have not completely recovered from the significant drawdown that occurred in the summer of 2011, suggesting that markets have further room to run.
We are not expecting to see uninterrupted smooth sailing from here, but we do believe that the trends for stocks are pointing in the right direction.
Modest Economic and Jobs Growth Should Continue in the Months Ahead
From a technical perspective, the market backdrop continues to be a strong one. All of the major indices are trading at above their 200-day moving averages and the advance/decline lines are trending quite strong. Additionally, mutual fund flows are starting to move in a positive direction for stocks with some evidence suggesting that investors are starting to get back into the markets (although the amount of cash on the sidelines remains high). Although economic and market data is looking better than it did months ago, it is important to remember that significant downside risks remain.
Stocks Advance Despite Softening Earnings Data
The recent bounce in stocks and in other risk assets can be attributed to a combination of some improved US economic data, a lack of significant new negatives in the euro debt crisis and further evidence of a soft economic landing in China. For the rally to continue, we believe at least two developments need to occur. The first is that we need to see policymakers in the euro area continue to stabilize conditions. The second is that we need to see global economic data continue to improve enough to support corporate earnings growth.
Double-Digit Market Returns in 2012?
Skeptics would suggest that the solid start to 2012 is little more than a typical "January effect" in which stocks tend to rise at the beginning of the year, but we think there is more to it than that. In part, we believe the upward moves of the last two weeks can be attributed to the fact that many investors (including active fund managers) came into the year underexposed to risk assets following a disappointing 2011, and who are at this point beginning to put their cash to work.
Muddling Through in 2012
The world continues to operate in a post-creditbust environment in which significant amounts of deleveraging still need to occur. The momentum in the United States is pointing in the right direction, but we do expect to see ongoing back-and-forth in the tone of economic data. Conditions will not continue to improve at the same pace we have seen over the last couple of months, nor will they deteriorate to the point that a double-dip recession becomes likely. Instead, we expect the economy to chart a middle course and grow somewhere between 2% and 2.5% for the year.
2012: A Look Ahead
2012 is likely to feature a slow-growth world that includes a recession in Europe. The US faces headwinds, but manages to achieve growth of between 2% and 2.5%. China and India slow somewhat, but, along with the US, make up two-thirds of global GDP growth. The big risk remains that of a financial breakdown in Europe, which would tip the developed world into recession. Inflation should also continue to move lower. Should the muddle-through environment come to pass, we believe earnings and some improvement in confidence would allow equity markets to move higher, with US stocks leading the way.
A Look Back at 2011
Although 2011 started off on a relatively strong note for the global economy and markets, the past year was dominated by fears that contagion from the European debt crisis would derail the recovery. Overall global economic growth struggled as most areas of the world experienced growth slowdowns (the notable exception being the U.S.) Emerging markets were also faced with some mounting inflation pressures, which presented a challenge for policymakers. Although there have been some signs of progress regarding the debt crisis, uncertainty levels remain high going into 2012.
Progress in Europe Lifts Sentiment
Market action last week centered on the European summit that took place on Thursday and Friday. While no one is suggesting that the debt crisis will go away any time soon, the framework agreement that was reached has at least reduced some of the anxiety and appears to have eased the gridlock in European financial markets. While these moves will do little to ease the near-term debt issues affecting many European countries, they are important. In our view, last week's summit may well represent the first tangible positive developments since the crisis began.
Markets Cheer Economic and Policy Progress
Although last week's news was positive it is too early to declare any sort of victory and it is important to remember that the market gains that occurred last week did not match the losses of the previous two weeks. However, it does appear that conditions are continuing to improve. The coordinated rate action and continued easy availability of money should ease some of the world's debt burdens. On the economic front, we are expecting GDP growth in the US to increase to at least 3% in the fourth quarter, which should provide further evidence that the macro backdrop is getting better.
Stocks Buffeted by Euro Fears and Super Committee Failure
Equity markets sank sharply last week as the European debt crisis worsened and the US super committee failed to come to an agreement. Congress still has an opportunity to address deficit reduction, but of course the fact that all of this is occurring with the backdrop of the 2012 elections means that uncertainty levels are elevated. As a result, unless and until more clarity emerges, markets are likely to remain somewhat trendless in the near term.
Conditions Continue to Improve, but Risks Remain
Notwithstanding last week's market setback, conditions have improved noticeably over the last couple of months. In late summer, many were predicting that there was a greater-than-50% chance that the US would sink back into recession, Europe was on the verge of falling apart and there were widespread fears of a hard economic landing in China. Today, it is growing more clear that not only has the US avoided a recession, but it is actually showing signs of growth acceleration, Europe is showing signs of progress (although much more needs to be done) and China appears poised for a soft landing.
Risks Remain High, But May Be Receding
We do not think the Fed is quite ready yet to enact QE3, but should we see some sort of combination of further chaos in Europe, inflation levels receding further and economic growth deteriorating, the likelihood would grow. On the economic front, last week saw the release of the October payrolls report. Gains were slightly weaker than expected (up 80,000), but the data also showed that gains in August and September were revised up sharply and that unemployment fell very slightly, from 9.1% to 9.0%.
Rally Continues on Positive News from Europe
Investor sentiment has certainly improved over the past several weeks, and while it is much too early to declare victory over the European debt crisis, last weeks deal is certainly a positive step. The easing of the risks associated with Europes issues, along with a brighter outlook for the US economy than was the case a couple of months ago does create a more solid footing for risk assets. Given the sharp advance markets have seen over the past month, we may be in for a period in which markets need to "digest" these gains, but the longer-term outlook for stocks does appear to be improving.
Markets Gain Ground, but Remain Range-Bound
S economic data has shown some encouraging signs in recent weeks. Retail sales figures and jobs indicators have trended to the positive, which has caused a number of economists to upgrade their forecasts for third- and fourth-quarter gross domestic product growth. The overall sense of economic uncertainty remains high, but it is looking increasingly likely that the United States will avoid a double-dip recession.
Investors Await Additional Clarity Around Europe
For the second consecutive week, stock prices moved sharply higher as investors welcomed the news of progress in addressing the European debt crisis and also took some solace in improved US economic data. For the week, the Dow Jones Industrial Average climbed 4.9% to 11,644, the S&P 500 Index advanced 6.0% to 1,224 and the Nasdaq Composite jumped 7.6% to 2,668. Other risk assets, including commodities, also experienced gains last week, while safe-haven assets such as US Treasuries struggled.
Positive Signs Exist, but Europe and Policy Are Unclear
It is difficult to assess value in the current environment. If the European debt crisis were to suddenly disappear, stocks would appear very cheap, but of course the uncertainty over the debt crisis remains the critical wildcard. From a technical perspective, over the past couple of weeks the S&P 500 tested the 1,100 low it reached in August and while that level was briefly pierced from a price perspective, stocks rebounded quickly which perhaps makes the 1,100 level a stronger floor. This is not to say that that level will not be tested again, but we do believe it is a good sign.
Markets Continue to Look for Clarity
The global financial stresses that have been contributing to market volatility have shown no signs of easing. Financial markets have been signaling that economic growth levels are too weak to support the current financial structure. Corporate bond spreads in most markets have been widening and euro-area bank bond spreads are close to their 2008 crisis levels. These signals suggest that economic growth needs to improve sharply (which is not likely to happen any time soon) or that further policy action is needed to ease the strain.
Market Outlook Hinges on Europe
We expect the economy will muddle through in the coming year and we would place decent odds that economic growth will improve from the 1% level it experienced in the first half of 2011. This view is predicated on the assumptionand it is a big onethat there is no major additional fallout from the European debt crisis.
Uncertainty Remains, but so too Does Opportunity
In contrast to Europe, the United States economy remains in reasonably good health. The United States does, of course, have its own sovereign debt issues to deal with and the future state of the federal deficit is an obvious source of concern. The difference between the United States and Europe is that the United States has the ability to solve its own fiscal problems, even if coming to an agreement about how to do so is a significant challenge. Given this backdrop, its hardly surprising that US stocks have been outperforming on a relative basis over the past couple of months.
Market Slide Continues, but Positives May Be on the Horizon
We are in the midst of a bear market in confidence more than anything else and investors should be on the lookout for signs that conditions will be getting better. There are a number of developments that could help restore confidence. Positive surprises in US economic data; lower interest rates in Europe; major European bond purchases; a eurobond issue; additional quantitative easing from the US Federal Reserve; the US Congressional super committee agreeing to major long-term entitlement reform; and US pro-growth tax policies that encourage capital formation.
Economic Recovery Poised to Improve
The U.S. will avoid a deep slump, but it remains an open question as to whether growth is modestly positive or if the US flirts with a recession. In any case, however, we do not expect to see a period of economic weakness that is anything like what we saw in 2007 and 2008. Unlike then, the US financial system is much better capitalized, the housing market is no longer overvalued and there is some demand in the cyclical parts of the economy. Additionally, we would point out that temporary factors are at least somewhat responsible.
Markets Recover Some Ground As Uncertainty Remains High
In some ways, whether or not the economy does sink into recession is a technical point. If we do see a double-dip recession, any such contraction should be mild. If the economy avoids a recession, growth will still be weak. From an earnings perspective, any decline that comes about in earnings growth due to economic weakness should also be smaller than the average contraction that occurs during a typical recession. Looking ahead, our forecast is that earnings growth flattens out while GDP remains very low.
Outlook: Cautiously Optimistic For Economy & Markets
Despite the overall negative tone among investors, not all of the news has been bad in recent weeks. Data regarding July pointed to the beginnings of a stronger economic second half of 2011, including better payroll figures, industrial production, unemployment claims and retail sales. Additionally the Index of Leading Economic Indicators actually rose in July and was ahead of expectations. However, it is important to remember that August is when all of the stresses in the credit markets and equities spiked, so it is very possible that this may negatively impact Augusts economic statistics.
Intense Volatility Rattles Investor Confidence
We believe investors are overly pessimistic about the possibility of a renewed recession in the U.S. It is important to remember that equity markets have a poor track record as acting as predictors of recessions and corporate fundamentals remain strong. Since 1950, the U.S. has never entered a recession with corporate balance sheets as flush with cash as they currently are-at present, nonfinancial companies are holding cash in the amount of around 11% of their balance sheets, the highest level in over 60 years.
Results 851–900
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