Don’s Outlook 2/26/10
The market continues to search for direction this week. After a near month-long slump caused by changing market conditions and the threat of tighter monetary policy abroad, the S&P 500 has rebounded just as quickly, rising from the floor of one moving average (the 150-day) to the ceiling of another (the 50-day). When only 21% of S&P stocks were trading above their 50-day moving average, the market was reaching a short-term oversold level and was ready to rebound. If it holds here, the correction will have been on par with the conditions investors experienced between 2003 and 2007, which is the last time the markets slowly climbed a seemingly endless wall of worry.
Federal Reserve Chairman Ben Bernanke’s semiannual testimony before Congress this week went largely as expected. Bernanke reiterated the Fed’s earlier statements regarding the need to maintain accommodative monetary policy for as long as economic conditions warrant. Although he did not provide actual signposts that would trigger a change in this stance, he did provide some economic signals that we can identify as significant. These include continued growth in private-sector demand; higher business investment in equipment and software; a tighter labor market; and an improving housing market. Among these indicators, there has already been an improvement in private demand, a rise in hiring temporary staff, and higher capital goods orders, all of which bode well for stability and additional economic strength.
Most client portfolios are currently divided equally between value and growth, and the overall allocation is skewed toward large-cap stocks. Historically, value-style investing has outperformed growth. This is particularly true during cyclical recoveries when the economy is expanding and cash flow expectations are steadier. Growth has outperformed during corrections and recessions when growth becomes scarce and investors are willing to pay more for it. Whether this remains true in 2010 is a story that continues to unfold.
Although we have more visibility this year from companies regarding their earnings projections, growth may be less robust than in previous recoveries because of ongoing headwinds, such as available credit, consumer balance sheets, and future monetary policy.
However, some of these issues are why I continue to emphasize large-cap stocks over small-cap fare. Despite their recent spurt of strength, I believe smaller stocks face a tougher environment ahead and have limited access to capital, even during normal conditions. Tighter credit standards and a reduction in bank lending will curtail their growth prospects, which may lead to additional volatility as the economy rights itself, especially for names of lesser quality.
