Second Quarter Directions, from Bob Doll, vice chairman, chief equity strategist for fundamental equities, and Curtis Arledge, managing director; CIO of fixed income, fundamental portfolios, BlackRock
While we believe the economic recovery has gained ground, structural headwinds warrant maintaining a center of gravity around high-quality equities. At the same time, investors should look to opportunistically add lower quality assets as buying opportunities emerge.
• Focus on higher-quality equities: As the economy continues to recover slowly,equity markets should continue to grind higher, albeit with some volatility along the way. In this environment, higher-quality equities should continue to outperform.
• Prefer US & Emerging Markets: The economic recovery has been strongest in emerging markets and the United States, and we continue to favor those regions.
• Spread Assets Look Attractive: Attractive opportunities can be found in fixed income spread sectors against the backdrop of an ongoing economic recovery, strong demand for higher-yielding assets and subdued levels of credit creation.
Equities Strength of Preference
Mixed Signals on the Economy, from Stephen J. Huxley, chief investment strategist, Asset Dedication
The American Institute for Economic Research releases its leading, coincident and lagging indicators of business cycle changes once a month. The organization has been tracking these numbers since the 1960’s, so these are respected measures.
Its March release had both good and bad news. The good news is that most of the leading indicators are positive. They are based on moving averages of data points from the past several months for each series. The bad news is that the most recent month added to the moving average—February, 2010—was negative for 7 of the 12 indicators. If they stay negative, they will signal that the nascent recovery that appears to be underway will dissolve.
The most worrisome negatives were the “new orders for consumer goods” and “new orders for core capital goods.” These are significant chunks of our economy and any declines are unwelcome sights. They signal that both people and businesses are not ordering equipment like appliances or machines. Also worrisome were the decline in new permits for apartment buildings and continue anemic growth in new single-family homes.
So what does it all mean? While we would all like to think that the recent improvements in the stock market (itself one of the 12 leading indicators) will lead us back to prosperity, the jury is still out. Even the prognosticators of interest rates are scratching their heads. According the Wall Street Journal this weekend, rarely have the quants at major firms been so far apart in their forecasts. Morgan Stanley sees a significant rise to 5.5% by year end for 10 year Treasuries, while Goldman Sachs sees a drop down to 3.25% from Friday’s 3.9%.
Nothing is clear at the moment except that predictability has never looked better to investors. Any strategy that can provide it should be welcomed into the investment community.
When Leading Indicators Peak, from Jeffrey Kleintop, chief market strategist, LPL
The first quarter of 2010 was a good one for investors. The stock market, measured by the S&P 500, posted a total return of 5.4%. Small company stocks, measured by the Russell 2000 index, were up an even stronger 8.9%. Even bonds, as measured by the Barclays Aggregate Bond Index, were up a respectable 1.8%. However, we believe gains are likely to be more modest going forward. One of the factors supporting our belief is that leading economic indicators may be at or near a peak.
One of the best leading indicators for the economy and markets is the Institute for Supply Management Purchasing Managers Index (ISM). Purchasing managers are at the front of the line when it comes to activity in manufacturing. Manufacturing companies need supplies to produce products and purchasing managers order these supplies. When demand starts to pick up for manufactured goods these managers need to order more supplies. When demand pulls back they respond by trimming their orders.
Although manufacturing makes up only about 40% of S&P 500 company earnings, demand for manufactured goods has proven to be a timely barometer of business activity of all types. This index is published at the beginning of each month, offering one of the earliest signals as to how the economy and outlook for business is faring each month.
The long history of the ISM shows us how effective it has been in signaling each recession and recovery. While the ISM has given a consistent signal when the recession is ending, it has also signaled when the recovery momentum peaks and the economy begins to transition to a new stage.
Looking back at the ISM over the past 35 years we can see that there have been a number of peaks and troughs that led the direction of economic and profit growth. The index has typically troughed around 30-40 and peaked around 60. Last Thursday, April 1, the ISM was reported for the month of March and the stock market welcomed the good news that the index rose to 59.6. However, now that it is at 60, there is a key question for investors: is it at a peak? If it is, returns are likely to be fl at and volatile going forward.
Over the past 35 years, the S&P 500 was up 18%, on average, in the 12 months prior to the peak in the ISM. However, once reaching the peak returns were flat and volatile. Over the six months following the peak, stocks were up only 1%, on average.
How Inflation Begins, by Jeffrey Saut, chief investment strategist, Raymond James
Annualized inflation in India is running at about 15% and China is not all that far behind. In the Philippines, March’s inflation figure was just reported at +4.4%, up from the previous month’s 4.2%, with the cost of Philippine fuel/electricity/water up 14.6% over the trailing 12 months. In our country, since January 2009 the price of copper is up ~185%, crude oil is better by ~118%, and rubber is higher by ~167%. Moreover, from August of 2009 until now hog prices have rallied ~75%, while cattle prices have lifted ~19%. Such actions caused the Reuters CRB Commodity Index to travel above its 200-day moving average in June 2009 and stay there ever since
(read: bullish and inflationary). Meanwhile, economists continue to insist there is no inflation because wage inflation is nonexistent.That, however, may be changing given some of the recent “worker strike” announcements.
To us, inflation is assuredly returning, yet the degree of inflation is unknowable. Why are we so sure inflation will return? It is because for decades that has been the easiest political solution for the debt accumulation of our citizenry and our government. To wit, pay back the debt with “cheaper” dollars. Given the recent geometric rise of debt, we see only three ways out for our government: sovereign default (unimaginable); severe economic contraction (unlikely); or, currency debasement (read: inflation). We choose Door No. 3 as the most likely course.
A Maturing Recovery, from Brad Sorenson, director of market and sector analysis, Schwab Center for Financial Research
The overall market has continued to grind higher, but we are starting to see some signs that sentiment might be extended a bit, leading to the possibility of at least a near-term pullback.
Typically, when economic recoveries start to enter a more mature phase—as indicated by a flattening in the growth rate of the leading indicators—sector leadership changes. The more cyclical, economically sensitive sectors that tend to outperform in the early stages of the recovery start to lag, while leadership moves to a more defensive tilt. Whether that will happen during this cycle is something we are still looking at, but we stand ready to move should we see more signs that leadership starts to change.
We continue to hold our outperform rating on the health care sector as we continue to believe value is compelling after the beating the group took during the health care reform uncertainties. Additionally, good dividends, solid balance sheets, and merger-and-acquisition possibilities increase the attractiveness of the health care sector.
On the other side of the equation, we continue to believe the consumer discretionary sector will underperform. The stocks in that group have done relatively well, and we believe they are a bit extended given the headwinds consumers continue to face in the form of higher taxes, elevated unemployment and a continued soft housing market.
A Trifecta Earnings Season? From Larry Adam, U.S. chief investment strategist, Deutsche Bank Private Wealth
Today is the “unofficial” start to 1Q10 earnings season with Alcoa reporting. Keep in mind that 26 companies have already reported, with 22 beating estimates. As the profit recovery continues to progress, we expect improvements to continue in top line revenues, earnings and margins. The S&P 500 typically rises, on average, half the amount that earnings revisions are raised in the 10 weeks after earnings season begins.
• Top Line. Given the rebound in domestic economic growth and very robust growth in the emerging markets, revenues are expected to grow by 9.3% (YoY) led by energy, materials and info tech. Utilities are the only sector that is expected to show a contraction in both earnings and top line revenues (YoY).
• Bottom Line. Earnings for 1Q10 are estimated to be up 38% led by financials, materials, consumer discretionary and info tech. Apart from 4Q09 (a record pace of +202% YoY), this will be the largest year-over-year earnings growth since 2Q88.
• Margins. Strong operating leverage, above average productivity, and continued cost containment should also allow for further improvement in margins.
• Calendar. This week will see 21 companies (approximately $1 trillion in market cap) report earnings, including bellwether info tech, financial and industrial companies. The biggest two weeks will be the next two (4/19/10 and 4/26/10), when we get 296 of the companies with over $6 trillion of market cap.
Monday, April 12:
Corporate Earnings: Alcoa
Tuesday, April 13:
Chain-store Sales (weekly), February International Balance of Trade, March Import/Export Prices
Corporate Earnings: CSX, Intel
Wednesday, April 14:
Mortgage Applications (weekly), March Consumer Price Index, March Retail Sales, February
Business Inventories, Federal Reserve Beige Book
Corporate Earnings: JPMorgan Chase, Yum Brands
Thursday, April 15:
Jobless Claims (weekly), March Industrial Production, April Housing Market Index
Corporate Earnings: Google
Friday, April 16:
March Housing Starts, April Consumer Sentiment
Corporate Earnings: Bank of America, General Electri, Mattel