by Bob Doll, Chief Equity Strategist, BlackRock
It has been quite some time since we have experienced two consecutive weeks without equity market gains. Given recent higher energy prices and some softening of economic data, however, that now has indeed come to pass. For the week, the Dow Jones Industrial Average lost 0.3% to 12,342, the S&P 500 Index fell 0.6% to 1,320 and the Nasdaq Composite declined 0.6% to 2,765.
Over the last several weeks, expectations for first-quarter economic growth have been ratcheted down. At the beginning of the year, the consensus forecast was for GDP growth to come in at around 3.5%, but that figure has since dropped to closer to 2.0%. Several areas of the economy have been pointing to slowing growth, including a softening of business spending on equipment and software, a slower-than-expected rise in inventories, weakening trade data and contracting construction activity for both the residential and nonresidential sectors.
Despite the downshift in expectations, however, some of the data remain encouraging. Private payroll figures have increased significantly over the last two months and the unemployment rate has fallen a full percentage point since November. The manufacturing sector has also continued to show signs of strength and, importantly, consumer spending levels have remained resilient. From our perspective, we remain reasonably constructive on the prospects for growth and continue to expect overall 2011 GDP growth to be somewhere around the 3.0% to 3.5% range.
Rising oil prices have been one of the main culprits for the pause in the equity markets as higher prices are causing concerns over inflation. Over the last four months, the headline Consumer Price Index (which includes energy and food prices) has advanced over 0.3% each month, a higher rate than we saw previously. Other inflation indices have also been moving higher in recent months. In contrast, however, core inflation (which excludes the volatile energy and food components) has remained tame. The big question, then, is whether and when we will see a pass-through of higher prices to other areas. At least so far, the uptick in inflation has remained contained to the energy sector. Whether this remains the case will be important to watch.
We are now at the beginning of first-quarter earnings season, and our view is that we should see solid results, although probably not as good as we saw in previous quarters. Top-line growth should remain strong, but we expect to see some localized margin pressures, particularly in some of the consumer-related sectors where higher raw materials prices are not being passed through to end buyers. In any case, however, overall financial conditions remain supportive for corporate growth and earnings should be able to come in at an above-trend pace.
At present, it appears that equity markets are remaining in a trading range marked by an S&P 500 level of between 1,250 and 1,350. The low number in the range was hit in the immediate aftermath of the earthquake in Japan and markets have since experienced a sort of relief bounce, but that bounce has stalled in recent weeks. Investors are facing a number of risks, including potential credit market disruption (particularly from peripheral European sovereign debt issues), a weakening in global demand levels caused by rising energy prices and the potential for a more rapid rise in core inflation in the United States than we expect.
Given that backdrop, a sustained breakout to the positive side of the current trading range looks unlikely at the moment. Although the macro economic and earnings environment remain conducive to higher prices in the long term, we believe markets will have difficulty sustaining gains in the coming months until we see some relief in energy prices.
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.
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 April 18, 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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