So Far, So Good, From Bob Doll, chairman and chief equity strategist for fundamental equities, BlackRock
First-quarter earnings season is now about halfway over, and on a dollar-weighted basis, earnings have beaten expectations by 18%, and revenues are 7% ahead of expectations. Against this strong backdrop, the Dow Jones Industrial Average advanced 1.7% to end the week at 11,204, the S&P 500 Index rose 2.1% to 1,217 and the Nasdaq Composite climbed 2.0% to 2,530. With these gains, stocks have more than offset the effects of the late January/early February correction and are now up more than 9% for the year. The leaders in terms of market sectors have been technology, consumer discretionary, energy and healthcare.
The stock market also has been benefiting from improving economic conditions. The heavy infusion of government stimulus early in the economic and financial crisis appears to have helped spark a turnaround. Leading economic indicators have continued to move higher and consumer spending levels have recovered at an extremely aggressive pace, particularly considering the fact that unemployment remains elevated. The residential real estate market remains troubled, but, on
balance, we expect that the US and global economies will continue to expand over the coming quarters.
In the United States, we expect gross domestic product (GDP) growth in the first half of the year will be close to 4%, with full-year growth of at least 3.5%. Growth rates also look to be strong in Asia, and while Europe continues to lag, we expect that region to show signs of economic improvement later this year.
The threats from the Greek debt crisis and Chinese policy tightening continue to
be a source of concern. Last week, Greece formally appealed for financial support from the European Union and the International Monetary Fund, and there has been increased speculation that we could see some sort of Greek debt restructuring. At the same time, the ultimate impact of monetary tightening in China remains unknown. These events remind us that risks remain for the global economy and financial markets, but as yet, they have not been enough to derail the bull market in equities and other risk assets.
An additional source of concern for many investors is the heightened scrutiny being faced by the banking system in general and Wall Street firms in particular. The charges against Goldman Sachs have been the most high-profile example of increased involvement in the financial system on the part of Washington, DC, and attention is now turning to negotiations over financial market regulation. The backdrop of the pending midterm elections is putting pressure on lawmakers to act, and it looks to us as if a deal will be in the works, meaning that we expect to see some new laws passed over the next month or two.
The New Abnormal, From Jeffrey Saut, chief investment strategist, Raymond James
In the debate on whether we will see inflation or deflation ahead, I must admit some things are indeed deflating while others are inflating (The New Abnormal). Nevertheless, I think the “seeds” for inflation have been planted. For centuries, anytime you created excess money and piled on
debt, the outcome has been inflation. Moreover, the spread between Fed Funds and GDP has been this wide only a few times; on every occasion inflation has followed.
Much of the no growth/low growth deflationists’ argument rests on a sated consumer who is not spending, but rather saving. We have already seen the spending cutback; one should never underestimate the ability of U.S. consumers to spend money even if they don’t have it! Moreover, U.S. consumers are currently saving about a half trillion dollars a year. At that rate they can match income and spending. As Milton Ezrati observes, “If incomes rise by 1 – 2% consumers can raise spending by 1 – 2% and continue to pay down debt by $500 billion a year. This amounts to about 4% of outstanding liabilities, so what consumers are doing is adjusting their balance sheets by 4% a year. That’s not great, but it’s not bad either.”
As for inflation, ISI’s temporary employment company survey of wage pressure has increased from 24.2 to 32.4, apartment rents are rising, import prices are up nearly 6% (annualized return), commodity prices have surged an eye-popping ~77% from their lows (MSCI), steel prices are scheduled to increase by a third, my son’s university tuition is going up, inflation is accelerating sharply in the emerging markets, and the list goes on. Speaking to the stock market, again I have been too soon’ly cautious, which is tantamount to being wrong. That said, investment accounts should still be pretty fully engaged, while my best idea for trading accounts is to bet on a pick-up in volatility.
WASHINGTON WORRIES, from David Kelly, chief market strategist, JPMorgan Funds
The week ahead should feature generally positive reports on both the economy and earnings. The economic numbers should show continued steady progress. Jobless claims should edge down, the Chicago NAPM index should edge up and labor costs should be relatively subdued, boosting profit margins in an expansion still featuring high productivity growth. Most important, the first quarter GDP number should be solid, showing roughly 3% annualized growth, even in the face of some weather-related disruptions. Yet despite this and despite an 80% move upward in the S&P500 from its low, measures of consumer confidence appear stubbornly low. The Conference Board number for April, due out on Tuesday, could show a decline from March, and while the University of Michigan Sentiment number, due out on Friday, could be more positive, the public remains in a very sour mood.
The earnings season should continue to provide positive headlines, with over 150 S&P500 companies set to report this week. Through last Thursday, 32% of the S&P500 companies (representing 47% of the market cap of the index) had reported. So far 79% of firms have beaten estimates with only 21% falling short. Moreover, the surprises have been big. At the start of the earnings season, analyst estimates suggested S&P500 operating earnings of $17.17 for the first quarter, essentially unchanged from the $17.16 seen in the fourth. This first quarter number is now running at $18.19 (combining actual reports with expectations for the companies yet to report) and, at this stage, hitting $18.50 for the quarter seems possible.
The Federal Reserve’s Open Market Committee will meet on Tuesday and Wednesday, releasing their usual terse statement at 2:15PM on Wednesday afternoon. The Fed isn’t expected to raise short-term rates at this meeting. However, as the expansion continues, they will come under increasing pressure to modify their commitment to keep rates low “…for an extended period.”
But, this may not be the right week to change the language either. As of Friday, the futures market was not pricing in a move to 50BPs before the fourth quarter. Any softening in the Fed’s language in an FOMC statement would likely cause investors to assume a more aggressive pace of tightening and could well lead to a back-up in long-term rates. With only one month of solid job growth in the bag, with core inflation drifting slowly down and with considerable uncertainty on credit availability and how it might be affected by financial reform, the Fed may well judge that it is still too early to head down this path.
For investors, even after an 80% move, stocks still appear cheaper than bonds in a strengthening economic expansion. However, the story is getting more complicated and investors should be a little more cautious.
PLAYING WITH FIRE, from Jeremy Grantham, chief investment strategist, GMO
The global equity markets taken together are moderately overpriced, and the U.S. part is now very overpriced but not nearly so bad as it could be. Surprisingly, within the U.S. the large high quality companies are still a little cheap, having been left totally behind in the rally. They are unlikely to do very well in a bubbly environment, however long it lasts, but should be great in declines and in the end should win. A potential plus for quality franchise stocks in the next few years is that they are far more exposed to emerging countries and, as investors fall in love with all things emerging, this should be seen as an increasing advantage. A mix of global stocks, tilted to U.S. high quality, has a 7-year asset class forecast of about 5% excluding inflation compared with a long-term normal of about 6%. Not so bad. On balance, therefore, we are only slightly underweight equities.
Within my personal portfolio, I have a stronger preference for the already overpriced emerging market equities than do my colleagues at GMO, and actually more than I should have as a dedicated value manager. This is because I believe they will end up with a P/E premium of 25% to 50% in a few years. The appeal of emerging’s higher GDP growth compared with the slow growth of U.S. developed countries is proving as compelling as I suspected, and I would hate to miss some modest participation in my one and only bubble prediction. It is hard, though, for value managers like us to ever overweight an overpriced asset, so we struggle on the margin to find kosher ways to own a little more emerging in order to give them the benefit of the doubt. I recommend that readers do the same. The urge to
weasel and own a little more emerging is a direct result of the lack of clearly cheap nvestment alternatives.
When is a Bond Not a Bond? From Stephen J. Huxley, Ph.D., chief investment strategist, Asset Dedication
International bonds have been touted as a good investment for diversification purposes. Emerging economies appear to be growing more quickly than first world economies, generating cash flows that make it easier to pay off all debts. Furthermore, many economists believe that the dollar will devalue over the long term, making non-dollar denominated assets a good bet.
But there’s downside to consider: From an individual client’s point of view, international bonds have much more in common with equities than fixed income as investments. Most people put bonds into their portfolios because they want conservative investments. If this is critical to an overall investment goal, international bonds might not make the grade.
The classic risks of bond investing—default risk, market risk, inflation risk and reinvestment risk—can be addressed with the proper strategies when dealing with individual domestic bonds. Any investor can use governments or AAA-rated bonds, hold them to maturity, and buy TIPS to avoid the first three. Investors who are withdrawing funds from their portfolios, like retirees, can avoid reinvestment risk if they use the coupon interest and redemptions to provide predictable, protected cash flows needed for living expenses: in other words, employ a “dedicated” bond portfolio strategy.
The international element adds new risks and reduces the advantages that bond investing brings to the table. Predictability and protection are lost because of exchange rate risk. In addition, there is political risk -- even bonds issued by a sovereign government may default due to fiscal irresponsibility (think Greece) or government takeovers (think Kyrgystan). Furthermore, international bonds are less liquid, typically carry higher transaction costs, and the market for them is less transparent and automated.
Those who want an aggressive stance in international investments can always buy international equities, of course. But conservative bond investors looking for predictability need to realize that international bonds may – or may not – fit the bill.
SURGE IN HOME SALES BORROWS FROM FUTURE, From David Rosenberg, chief economist and strategist, Gluskin Sheff
With a month to go before the homebuyer tax credit expires in the U.S., surprise, surprise, we see a ripping 27% MoM surge in new home sales, to a 411k annual unit rate (steepest increase since April 1963). However, even with that marvelous March result, in Q1, new home sales still managed to slide at a 14% annual rate. Nonetheless, homebuilding stocks and copper prices took off and bonds lost ground; it would be so much more impressive if it wasn’t so transitory.
As was the case last fall — ahead of what we all thought was the end of the first-time homebuyer subsidy, not to mention the same impact cash-for-clunkers exerted on auto sales late last year — what we have is a brief surge in activity to be followed by a prolonged lull. Keep in mind that the March figure followed four months of deep disappointment. In fact, the level of new home sales is basically the same as the consensus believed we would be at by now when you look at the monthly growth estimates heading into the data releases since last December.
Even with the tremendous amount of policy stimulus, home sales are still down around 70% from their pre-recession highs. It is still taking a record median 14.4 months for homebuilders to locate a buyer upon completion of the unit. In addition, the fact that median home prices fell 3.4% last month (average prices slid 11% in the second sharpest monthly decline in the 35-year history of the data series) is testament to the view that demand is still experiencing trouble keeping up with the available supply.
Earnings Explosion? From Larry Adam, U.S. chief investment strategist, Deutsche Bank Private Wealth Management
With 178 companies (almost half the market cap of the S&P 500) having reported 1Q10 earnings, earnings continue to migrate higher with 82% of the companies having beat estimates thus far. As a result, 1Q10 earnings growth has moved up from +38% (YoY) at the beginning of earnings season to over +50% (YoY) as of last Friday. Leading the growth is financials (+347%), materials (+178%), consumer discretionary (+125%), and tech (+60%). This week, we get another 168 companies (28% of the S&P 500 market cap) reporting, including major energy, industrial, and consumer staples companies.
REPORTS CALENDAR
Monday, April 26: Corporate Earnings: Advent, Ameriprise, BlackRock, Boston Scientific, Caterpillar, Humana, Texas Instruments
Tuesday, April 27: February S&P/Case-Shiller Housing Price Index; April Conference Board Consumer Confidence Index; April State Street Investor Confidence Index
Corporate Earnings: 3M, Aflac, ADP, Broadcom, Deutsche Bank, DreamWorks, DuPont, Ford, Kansas City Southern, Newmont Mining, Waddell & Reed
Wednesday, April 28: Mortgage Applications (weekly); FOMC Announcement
Corporate Earnings: Allstate, Baidu, Dow Chemical, Fair Isaac, Franklin Resources, Glaxo SmithKline, Goodyear, Honda, JetBlue, Lincoln National, Medco, Merck, Morningstar, Tyco, Verisign, Visa
Thursday, April 29: Jobless Claims (weekly)
Corporate Earnings: Aetna, Artio, Bayer, Bristol-Myers Squibb, Columbia Bancorp, Eastman Kodak, Exxon Mobil, Genworth Financial, Hartford Financial, International Paper, McAfee, MetLife, Motorola, Procter & Gamble, Unilver, Viacom, Wisdom Tree
Friday, April 30: GDP for First Q 2010; Employment Cost Index for First Q 2010; April U. Michigan Consumer Sentiment Index; April Farm Prices
Corporate Earnings: AIG International Real Estate, AON, Chevron, Fortis, Oppenheimer Holdings
