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Banc of America Securities-Merrill Lynch said last Tuesday it expects the S&P 500 to hit 1,200 over the next 12 months, helped by a “slow but sustainable” U.S. economic recovery that will keep inflation and interest rates low. The bank increased its outlook for S&P 500 earnings to $70 a share, from $69. It singled out financial stocks as the best play on domestic recovery and energy stocks for global growth. “We do not expect U.S. consumer spending to lead the recovery and many big-cap, U.S.-tilted consumer discretionary stocks seem too far ahead of the market,“ wrote David Bianco, head of U.S. equity strategy. “We see the recovery led by ‘late-cycle’ parts of the economy, such as business spending, infrastructure investment, rising commodity prices and exports.“
Source: Marketwatch
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In this commentary we address some of the negative perspectives which contrast with our own more sanguine view of the stock market over the near to intermediate term. One of the more widespread fears is that the improvement in the economy in recent months is not sustainable, and we are headed for another sizable decline in both economic output and the stock market. A key rationale for this thesis is that the economy will weaken considerably once government stimulus dollars begin to abate. We do not share this view. Our belief is that financial crises are often crises of confidence, and therefore government efforts to stabilize the financial system can have an outsized impact beyond just the dollar amounts being spent. Additionally, certain fiscal stimulus efforts do have multiplier effects. For example, the “Cash For Clunkers” program clearly increased auto sales. This persuaded manufacturers and their suppliers to increase production rates which itself required additional hiring. The impact continues as these employees now have more income to spend which further benefits the economy overall. While this is just one example, it is illustrative of the positive impact that effective stimulus outlays can create.
Another concern is the health of the financial system. While we concede that there are still problem loans on banks’ balance sheets, policy efforts have had a strong impact here as well. Most of the key indicators that we monitor to determine confidence in the financial system (an example being inter-bank lending rates) have normalized considerably over the last several months. Additionally, it is our opinion that the increased scrutiny with which regulators are examining banks today has created far more clarity than normal regarding the health of the financial system. It is also comforting that the government has earned a handsome return on the portion of TARP funds which have been repaid thus far.
Lastly, many allude to the strong run that the market has had since bottoming in early March and fear that stock prices have gotten ahead of themselves. While it is true that the market has soared over 40% in recent months, we caution against putting too much weight on any one particular time period. One could just as easily point to the fact that even with the recent advance, the S&P 500 is still 35% below its October 2007 peak. It is probably more constructive to take a longer term view, in which case it is noteworthy that the stock market (as measured by the S&P 500) is currently at levels first reached in February of 1998. While we recognize that there is a reasonable likelihood for a short term pullback, we would view this as a normal and in fact healthy event which would require only minor tactical portfolio considerations.
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In Eagle’s latest money manager commentary, they explain what has been happening in the Small/Mid cap sector of the stock market since the March market lows. Low quality stocks have been out-performing high quality stocks. The stocks with the highest gains have been those with the lowest return on equity. These low quality stocks are not even expected to produce any earnings over the 12 months. Historically this has not been able to hold – since 1991 stocks that have produced earnings out-perform those that do not by about 300%.
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Has the stock market come too far too fast during the past six months? At these current levels and valuations, are equities overbought and expensive? Money management firm BlackRock investigates these issues and also dives into the latest economic news that has helped shape the market over the past few weeks.
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“We continue to believe that the recession is coming to an end and that US gross domestic product (GDP) growth will be positive in the third quarter. Based on historical patterns, a recession of the current magnitude would typically result in GDP growth levels of between 6% and 8% over the next 12 months, but with the economy still facing deleveraging and credit issues, we expect growth to be, at best, half of those levels. In the near-term, economic growth will benefit from an end to inventory liquidation and ongoing fiscal stimulus, but a sustained recovery will be difficult to achieve without jobs creation. By our analysis, the leading economic indicators are suggesting that we may start to see some growth in jobs by the end of this year, which would be good news.“
Source: BlackRock Investments, LLC
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Goldman Sachs provides its August 2009 Market Pulse summary with a slightly more technical approach. The money manager’s thoughts on short and long-term GDP influences, unemployment figures, Fed Policy, and the consumer, are all summarized and accompanied by insightful illustrations. Fixed Income predictions and an analysis of the booming middle class in Emerging Markets are also discussed.
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Despite signs of improvement, the economy and the financial markets still face many threats. Loan losses, higher commodity prices, commercial real estate, and rising interest rates can still hinder a full recovery. The multitude of Federal Reserve and Treasury programs seemed to have stabilized the markets and appeased its participants. But going forward can government intervention continue to play a key role in shaping the domestic and international economies? Money manager Earnest Partners believes they are well positioned to continue to deliver good results with or without government involvement.
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The past year has been one of the most volatile periods in history for the capital markets with investor panic, a credit market freeze, and a sharp downturn in economic growth. Aggressive interventions by the federal government appear to have done their job of avoiding an economic disaster. The result has been a sharp market rally since March, and a narrowing of spreads between Treasuries and other fixed income securities. The economic environment is still uncertain, and money managers, and private asset management firms, will need to return to their basics to focus on what they can control – investment discipline, fundamental research, and diversification.
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Fayez Sarofim believes the severity of the downturn has eased, worst-case scenarios have been avoided, and there is increased evidence that cyclical forces for recovery are gaining strength. Although recent economic data has been showing signs of stabilization, a self-sustaining recovery will depend on an improved backdrop for the consumer.
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The global economy is still in a recession that won’t end until the end of the year, said Nouriel Roubini, the New York University economist who predicted the global financial crisis.
“There is now potentially light at the end of the tunnel,” Roubini said today at the Diggers and Dealers mining conference in Kalgoorlie, Western Australia. Roubini was dubbed Dr. Doom for predicting the crisis. “I don’t think this recession will be over until the end of the year.”
Roubini, chairman of Roubini Global Economics and a professor at NYU’s Stern School of Business, predicted on July 23 that the global economy will begin recovering near the end of 2009 before possibly dropping back into a recession by late 2010 or 2011 because of rising government debt, higher oil prices and a lack of job growth.
Former Federal Reserve Chairman Alan Greenspan said yesterday the most severe recession in the U.S. in at least five decades may be ending and growth may resume at a rate faster than most economists foresee.
The U.S. economy is likely to grow about 1 percent in the next two years, less than the 3 percent “trend,” Roubini said last month. President Barack Obama said on July 30 the U.S. may be seeing the beginning of the end of the recession.
The global economy will contract 1.4 percent this year, deeper than forecast in April, and a sustained recovery from the worst recession since World War II may be a year away, the International Monetary Fund said July 8.
Source: Bloomberg
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