Equity Strategy
Current Conditions & Your Equity Investment Strategy
Every week our top equity strategists discuss current market conditions and how your equity strategy may be affected.January 5, 2008
All three major indices finished significantly higher in last week's trading. The S&P 500 jumped 6.8% (Year-to-date up 3.2%), the Dow Industrials rose 6.1% (YTD up 2.9%) and the NASDAQ Composite gained 6.7% (YTD up 3.5%). Five of 10 S&P sectors outperformed the Index but all ten rose strongly on the week. The best performing sectors were Energy (up 9.6%), Consumer Discretionary (up 8.4%) and Industrials (up 7.9%). The worst performers were Consumer Staples (up 3.8%), Health Care (up 4.8%) and Telecom Services (up 5.3%).
As we look into the middle part of 2009, we expect the economic news and earnings results to slowly improve. However, as the last couple of weeks have shown, most of the government reports on economic activity will likely look pretty dismal in the near term. Housing, a key indicator for the overall economy in our opinion, is still trying to find a bottom as prices continue to fall and volumes attempt to stabilize. We look for better housing news in the second half of the year. Employment data, mostly a lagging indicator, will likely not show improvement until late in 2009. Companies are typically slow to hire once the economy bottoms because they want to make sure business volumes will improve before adding fixed costs. We do see better times for the stock market this year as investors anticipate economic stabilization with better earnings comparisons in the second half. The U.S. government is spending hundreds of billions of dollars to improve the functioning of the credit markets and the incoming Obama administration is expected to drop hundreds of billions (maybe $1 trillion) more into the economy over the next 12-24 months in the form of tax cuts, rebates and business incentives. These efforts should help stabilize the economy and allow single digit positive earnings comparisons for the S&P 500 by the fourth quarter. Markets are starting to anticipate a recovery as outperformance of the more defensive sectors like Health Care and Consumer Staples has stalled and smaller and mid-capitalization stocks have begun to outperform. We see these as positive signs.
This week's economic calendar features reports on construction spending and motor vehicle sales (Monday), factory orders and the ISM (Institute for Supply Management) services survey (Tuesday), consumer credit (Wednesday) and weekly initial jobless claims (every Thursday). Vehicle sales do not look to recover any time in the near future as consumers retrench and hold off on purchases of big ticket items like cars. The ISM survey reading will probably fall in the mid to upper 30s range, well below the 50 level. Readings above 50 signify expansion while readings below 50 signify contraction. While this indicator is relatively new (the ISM manufacturing survey has been around much longer), this week's reading could mark a record low. The most watched report of the week will be Friday's employment data for December. It appears likely that the rate of unemployment will jump to 7% from the 6.7% reading in November. Non-farm payrolls likely fell slightly less than 500,000 after a 533,000 drop in November. Remember, as mentioned above, employment data tends to be a lagging not leading indicator. It is typical for labor data to worsen well past the actual economic trough. Also note the FOMC (Federal Open Market Committee) minutes from the December meeting will be released on Tuesday. There will probably not be many surprises here. Clearly, the Fed is pulling out all stops in an effort to get the credit markets and ultimately the economy moving again. We do not expect the current Fed Funds target rate range of 0% to 0.25% to change any time soon.
Since the stock market tends to lead (anticipate) the actual economy, we believe investors would be wise to prepare their portfolios now for an economic recovery over the next 6-12 months. We expect any recovery to be slow with GDP growth rates below the long term trend (approximately 3%) for some time. More cyclical sectors should lead the stock market, and eventually, smaller and middle capitalization names. Earnings comparisons look to be negative but improving through the first three quarters of the year. Full year 2009 earnings are likely to be down 9% to $65 after a 17% decline in 2008. We look for the S&P 500 to trade at 14x to 15x our earnings estimate for 2010 of $78 by the end of this year. That would translate into a target range of 1100-1200 by late in the year.