Markets Enter Correction Territory As Economic Concerns Escalate (Doll)

Outside the United States, we are hopeful that we will see some clarity around the European sovereign debt issues. Europe will likely remain a troubled region and growth will be weak, but we believe that the eurozone will hold together. Additionally, we think there is a good chance that Chinese policymakers will be successful in lowering inflation and engineering a soft landing, which would also take some risks out of the market.

Federal Reserve action could also represent a potential positive. While we are not expecting to see a new "QE3" type of program (unless the economy performs significantly worse than we expect), should the Fed merely choose to announce it will maintain its balance sheet for an extended period, that would represent a de facto form of quantitative easing.

It is also possible that we could see some progress on the US political front. There is a very low likelihood that Congress and the President would be able to agree on some sort of package that would result in significant structural changes designed to create capital formation and hiring, but there is an outside chance that the weakness in the economy could prompt the parties to come together to enact some new policy initiatives on that front. More likely would be some sort of agreement to extend the current payroll tax cuts or to extend unemployment benefits, both of which would help promote economic growth.

Finally, we would point to corporate earnings. Corporate earnings have long been a source of strength, and despite the weakness in the economy, companies have been able to show impressive growth. The most recent data from the second quarter shows that over 75% of companies have beaten expectations and the average beat has been by 5%. This is not a new phenomenon. Earnings are up 128% since the market lows in March 2009. In contrast, the S&P 500 is up 80% over that same time. As a result, stock valuations are more attractive now than they were when markets were at their worst during the credit crisis, and particularly so as compared with bonds.

What should investors do?

There is a great deal of fear and risk present in the markets, and we are hardly suggesting that everything will be smooth sailing from here, but nothing that has happened over the last couple of weeks fundamentally alters our cautiously optimistic outlook for stocks.

Our summary view is that if investors believe (as we do) that the US will avoid recession, then continued overweights in risk assets makes sense. Cash is still yielding essentially zero percent, and Treasury yields have fallen sharply as well, so compared to alternatives, stocks continue to represent an attractive option.

We expect to see continued high levels of volatility in the weeks ahead given the lack of clarity around all of the issues we outlined earlier, but we do believe that conditions should improve. We are closely monitoring economic and sentiment signals, as well as the labor market, as new trends could be starting. This is not a time that investors should panic and overreact to short-term market swings. Maintaining a focus on long-term objectives is always critical during times of market stress.

Two weeks ago, we did not think that stocks were expensive. Now, with markets lower by 10%, stocks are pricing in a more negative scenario than we expect. To us, this suggests that the present market could represent an opportunity to accelerate moves out of cash and Treasuries and into risk assets.

About Bob Doll

Bob Doll is Chief Equity Strategist for Fundamental Equities at BlackRockĀ® a premier provider of global investment management, risk management and advisory services. Mr. Doll is also Lead Portfolio Manager of BlackRock's Large Cap Series Funds. Prior to joining the firm, Mr. Doll was President and Chief Investment Officer at Merrill Lynch Investment Managers.
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of August 5, 2011, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks.

 

International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.

Prepared by BlackRock Investments, LLC, member FINRA.

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