Investment Commentary
BlackRock Investment Management
By Bob Doll
January 10, 2011
Despite a disappointing December labor market report last week, the overall tone of economic news continued to be positive, which helped equity markets start 2011 on a strong note. For the week, the Dow Jones Industrial Average climbed 0.8% to 11,675, the S&P 500 Index rose 1.1% to 1,272 and the Nasdaq Composite advanced 1.9% to 2,703.
December’s jobs report showed that private-sector payrolls rose by 113,000 for the month and that net new jobs were 103,000, numbers that were below expectations. At the same time the unemployment rate (which is measured by a separate survey) fell noticeably, declining from 9.8% to 9.4%. One of the silver linings to the data was that upward revisions for jobs growth in October and November were reported. Our bottom-line analysis of the report was that it represented a somewhat disappointing set of headline numbers, but that jobs are continuing to grow at a modest pace and we continue to expect improved jobs growth levels in the months ahead.
The overall economic picture is one of gradually declining levels of uncertainty as the United States and the world economy are beginning to transition from recovery to outright expansion. In the United States, we are expecting the expansion to begin in the second quarter of this year and we are also expecting to see growth levels evolve from being driven by inventory restocking and government stimulus (as was the case in 2010) toward increased final demand (consumers and businesses spending money). Such growth is more sustainable in the long term, and should be conducive to better employment figures.
This is not to say, however, that 2011 will be a year of smooth sailing for the economy. Two of the issues that caused problems in 2010, sovereign debt crises and emerging markets inflation, are likely to continue to threaten overall levels of global economic growth. We expect these issues will continue to surface over the course of the coming year, and will cause some degree of contagion in global markets, but we do not believe that either issue will be enough to depress the world economy or derail the current bull market. Closer to home, another area that bears watching is the housing market. Housing is perhaps the sole sector of the US economy that has yet to show any meaningful and lasting signs of improvement over the past several months, but at least the housing market does not appear to be dragging down the rest of the economy.
An additional area of concern as we look to the coming year is the situation with state and local governments, which continue to face budgetary pressures. States and local municipalities will likely be cutting spending levels and/or raising taxes in the months ahead to make up for budget shortfalls, and we believe that spending cutbacks will shave approximately 0.5% off of US gross domestic product growth over the course of 2011.
One bright spot in this area is that state and local tax receipts have been rising noticeably in recent months as a result of the economic recovery. In addition, at the federal level, we may also be contending with some higher tax rates. The Obama Administration has signaled that it may propose a cut in corporate income tax rates, but given that the Administration is also looking to close some tax loopholes, any restructuring of corporate taxes may well result in a net tax increase rather than a decrease. There is also a possibility that the Administration and Congress may address potential solvency issues in Social Security by lifting the cap on payroll tax rates and by slowly phasing in a higher retirement age.
The fourth-quarter earnings season is set to begin, and we think the expectations bar is set relatively low, which should set the stage for another quarter of positive earnings surprises. Our expectation is that around 70% of companies will report better-than-expected results, which would continue the trend of corporate earnings growth levels exceeding that of the overall economy.
In sum, we see a number of potential risks for the economy and the markets in the year ahead, including sovereign debt issues, emerging markets inflation and the possibility of higher tax rates, but we remain positive on the overall environment. Inflation should remain low throughout 2011, economic growth should accelerate slightly with the quality of that growth improving, and corporate earnings should remain strong — an environment that should provide a solid backdrop for stocks to post further gains over the course of the year.
(c) BlackRock Investment Management
