Investment Commentary
BlackRock Investment Management
By Bob Doll
January 18, 2011
Stronger-than-expected economic data and a solid start to the fourth-quarter earnings season helped push stock prices higher for the seventh consecutive week, with the Dow Jones Industrial Average climbing 1.0% to 11,787, the S&P 500 Index advancing 1.7% to 1,293 and the Nasdaq Composite rising 1.9% to 2,755.
At present, it appears that the competing forces driving the market are the worldwide bullish backdrop of the global economic recovery, falling uncertainty levels and attractive risk premiums for stocks in most markets and the bearish local problems of sovereign debt issues, rising inflation in emerging economies and US state and local budget problems. Our view is that while these localized issues are likely to surface and cause problems from time to time, the bullish backdrop for the economy and equity markets is likely to prevail.
Regarding the economy, the data has remained generally positive over the last several months, with the notable exception of the labor market. The recent December employment report was disappointing, but we are viewing that as an outlier and believe the jobs market is poised for a recovery. The leading indicators of jobs growth, including initial unemployment claims, hours worked and profitability levels, are moving in the right direction, and we expect to see hiring levels increase soon. For its part, the corporate sector remains in extremely good health. We believe that fourth-quarter earnings will beat consensus expectations (marking the eighth consecutive quarter of that occurring), and with corporate debt levels low and profit margins high, companies appear ready to begin spending their cash more freely, and we expect hiring plans to ramp up. Should that occur, and should we see meaningful improvements in the labor market, overall confidence levels will receive a bounce.
The political backdrop in the United States is one of the important factors that is driving investor sentiment. The ongoing budget debate is likely to result in some modest cuts in discretionary spending and may include some spending caps. It is also possible (but much less likely) that Congress and the Obama Administration will address the long-term structural problems that are being driven by Social Security, Medicare and Medicaid. (Over the coming decade, these entitlement programs are likely to grow at twice the rate of GDP.) Our hope is that the government will focus on job creation in the short term and on deficit reduction in the long term. If progress can be made on both fronts (and we recognize that is a big “if”), investor sentiment will certainly improve.
Outside of the United States, the European Central Bank (ECB) responded to some recently higher inflation readings by adopting a more hawkish tone, suggesting that interest rate hikes may be on the horizon (although they are unlikely to happen soon).
The ECB highlighted the economic divergence between “core” and “peripheral” European economies, and underscored how important it is that European Union authorities address Europe’s fiscal problems.
As we indicated earlier, we expect that the more bullish forces will prevail over the coming months, but we acknowledge that risks remain. The strong run-up we have seen since the August lows could mean that markets are overdue for a pullback, but should that occur, we would argue that any near-term weakness would be an opportunity for increasing equity positions since the cyclical backdrop is likely to remain equity-friendly.
(c) BlackRock Investment Management
