Don’s Outlook 7/30/2010
Although our policymakers and mixed economic data have set a mixed tone for the market, corporations are doing their part to turn the tide of this recovery. During the Federal Reserve’s semiannual testimony to Congress, Chairman Ben Bernanke painted the picture of an unusually uncertain economic environment, and his comments were followed up this week with a subdued Beige Book, which showed the potential for an economic slowdown even though manufacturers were expanding. Meanwhile, the initial second quarter reading of gross domestic product also showed a slight slowdown, declining 0.3 percent to a 2.4 percent annual rate.
While weak U.S. economic data points over the past two months have forced many economists to revise their 2010 growth projections, few were willing to cut their 2011 numbers as quickly, preferring to characterize recent results as a soft patch rather than foreshadowing a double-dip recession. Corporations are doing their part to post strong results and continue to show signs of recovery. The second quarter earnings season has been largely positive, with many sectors beating analysts’ estimates and aggregate earnings rising for the S&P 500. Industrials and technology have been among the strongest sectors and have provided the best guidance for the current quarter.
Many bearish investors have looked to the U.S. bond market for both a refuge from the correction, as well as confirmation that the economy is headed for a recession. Although the softer economic data and uncertainty over future policy were enough to fuel bond prices higher, the economy is far from static. In fact, private demand has been clearly stimulated via fiscal and monetary policy initiatives, but now the U.S. economic recovery must move from a government led affair to one that is driven by consumer spending and business investment. The fact that bonds have performed so well has likely more to do with an accommodating Federal Reserve, low inflation, and modest capital demands to date. Once any of these reverse, we are likely to see progressively higher interest rates.
Although swings in investor sentiment are unavoidable, I remain positive considering valuation levels, global earnings, and macroeconomic data. The European stress tests from last week were largely benign, China appears to be backing off its monetary tightening stance, and investors’ appetite for risk looks set to return once we break free from the recent trading range.
