Outlook: Cautiously Optimistic For Economy & Markets
by Bob Doll, Chief Equity Strategist, BlackRock
August 22, 2011
Stocks Sink Sharply Again
Continuing problems regarding Europe’s sovereign debt issues, some mixed data on the US economy and rising concerns over the possibility of a renewed recession helped push stock prices sharply lower again last week. For the week, the Dow Jones Industrial Average dropped 4.0% to 10,818, the S&P 500 Index declined 4.7% to 1,124 and the Nasdaq Composite fell 6.6% to 2,342. Importantly, however, markets are still above the lows they reached a couple of weeks ago when panic selling reached its peak.
New Fed Action on the Horizon?
One of the economic highlights last week was July’s consumer price index report, which showed inflation rose by over 3.5% from last year, the highest reading in nearly three years, with owner-equivalent rent being among the price gauges that rose most dramatically. This higher inflation reading is putting the Federal Reserve in the spotlight, particularly with their Jackson Hole conference coming up soon and their recently sharply lowered assessment of the economy. Based on their recent statements, it does not appear that the Fed is forecasting that the US economy is headed for recession, despite the fact that stocks are forecasting one and that many investors believe a new recession is coming. However, the Fed may also believe that with the difficult situation in Europe, the drop in confidence and the tightening of financial conditions could derail the already-weak levels of economic growth.
At this point, the Fed appears to be weighing its options in terms of whether or not it would choose to engage in some sort of additional easing measures. The central bank likely wants to remain on hold until more information is available, but continued deterioration in financial markets would likely increase the odds that the Fed would ease in some way. Future moves by the Fed could include an extension of the maturity and duration of the central bank’s balance sheet, although some would argue that the Fed already engaged in de-facto easing by their recent announcement that rates would stay near zero for another two years.
Despite Weakness, a New Recession Remains Unlikely
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 payrolls 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 August’s economic statistics.
The question, then, is whether or not the United States will experience a new recession. The concerns on the “yes” side involve lingering effects from the rise in oil prices and the Japan supply chain disruptions that occurred earlier in the year, contagion from European financial stress and dysfunction in Washington, DC that could negatively affect the confidence in financial markets. In contrast, those opting to answer the question “no” would cite the zero-interest-rate environment, a positive yield curve, a cheap dollar, reasonable support from emerging markets growth and a strong corporate sector. From our vantage point, we continue to lean toward the positive and believe that the United States will avoid a recession, but will remain in a very slow-growth environment.
The situation in Europe remains a wild card. Last week’s summit between European leaders indicated that some progress has been made, but many were disappointed that more action wasn’t taken. Our view is that, ultimately, Europe will move further down the path of greater fiscal integration, possibly by adopting some sort of euro bond approach, but the path to get there will be extremely difficult given both the political constraints and the difficulties of harmonizing fiscal policies.
More Near-Term Volatility Likely
During times of heightened market volatility, investors tend to focus on technical market levels to look for trading ranges. At present, one of those levels appears to be 1,250 for the S&P 500, which was an important floor for prices before the decline commenced a few weeks ago and now represents an important ceiling. The other level looks to be 1,100, which was the low reached during the height of the panic selling. For the time being, we expect to see a fair amount of volatility as markets move between those two numbers.
Given the high degree of uncertainty and the extreme volatility in markets, it is not surprising that investors have been choosing to sit on the sidelines amid a “buyers strike” until more clarity emerges (which may come in the form of new policy or central bank action).
From a valuation perspective, stocks appear quite attractive both relative to their own history and relative to investment alternatives. To us, this suggests that the long-term outlook for equities remains attractive, but investors will need to remain patient.
About Bob Doll
Bob Doll is Chief Equity Strategist for Fundamental Equities at BlackRock® 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.
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Sources: BlackRock, Bank Credit Analyst. 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 22, 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.
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