After a fabulous week, what’s next? The word from David Kelly, Jeremy Grantham and more…plus, the week’s upcoming reports

BIG ECONOMIC NUMBERS, From David Kelly, chief strategist, JPMorgan Funds
The week ahead should be an important one for economic data, earnings numbers and the recently revived stock market rally.
 
On the economy, New Home sales numbers, due out on Monday should confirm the modest improvement seen in other housing data for June. However, other numbers in the middle of the week could disappoint. Consumer confidence could well have slipped in June even as economists feel better about the outlook. Consumer confidence is impacted by unemployment more than anything else and unemployment is rising. Moreover, confidence may have been boosted by the election of a new President in November, and a fading honeymoon, as is evident in his poll numbers, could also trigger a consumer confidence relapse. Durable goods orders could give back some of May’s stronger-than- expected gains while unemployment claims may have risen in the latest week as seasonal adjustments turn less favorable.
 
However, the big economic numbers are due out on Friday. The second quarter GDP number looks likely to come in negative, but only just, at a projected -0.1%, which would be a significant improvement from the -6.3% and -5.5% in the fourth and first quarters respectively. Also notable, in this report will be revisions to history going back a number of years which could potentially change the shape of the recession thus far.
 
 What shouldn’t change, however, is the perception that the economy is very close to growth with GDP being restrained only by continued very sharp inventory reductions. In addition, a close to flat GDP number for the second quarter, combined with very low wage growth (which should be confirmed in the ECI report due out at the same time), suggests that corporations have been very adept at increasing productivity and controlling wages over the recession, a harbinger of much better profit growth over the next few quarters.
 
Finally, on second-quarter earnings reports, with more than half the capitalized value of the S&P500 now reporting, it still appears that earnings will come in between $14 and $15 for the quarter. This would be down mid-teens from the second quarter of 2008 but up from $10 in 2009Q1 and $0 in 2008Q4. It should be noted that the average firm in the S&P500 has seen a more severe year-over-year decline but the change in the composition of the index over the past year has been highly favorable. Another 144 S&P500 companies report this week, so by Friday, the second quarter picture should be mostly complete.


NOW WHAT? From Jeremy Grantham, chief investment strategist, GMO
In March and April, I wrote about Plan A: you must force yourself to invest in a cheap market even when you are terrified by rapidly falling prices, as I admit I was to some extent. I also suggested Plan B: if you missed the earlier lows, you must grit your teeth and phase slowly into a cheap market. You can’t gamble that it will oblige you by another low, and historical analogies with earlier, much lower market lows are fraught with genuine differences. Now it is time for Plan C.

Plan C: What to do if the Market Overruns

Given our view that we are in for seven lean years in which the market will be looking for an excuse to be cheap, we recommend taking some risk units off the table, including becoming underweight in equities – between 1000 and 1100 on the S&P, if it gets there this year. Around 880 you should continue to move slowly to fair value, twiddle your thumbs, and wait to see what happens. Boring! Otherwise, it is time to focus on the lesser issues: which types of equities are cheaper or more expensive than the market. This leads us back once again to the bet on quality stocks.

The Quality Bet

The easy winner of the cheapest equity sub-category contest is still high quality U.S. blue chips. They were really trashed on a relative basis by the second quarter rally in junk. I understand a rally in junk after the record decline, but this was excessive and based apparently on unrealistic hopes for a strong, sustained economic recovery. Such a recovery seems most unlikely, whereas a temporary, weaker recovery appeared very likely three months ago as the substantial size of the stimulus package was revealed. The latter scenario still seems probable.