I think we’re going to get more of the same over the coming quarters—choppy economic news and choppy stock market trading. The key I think is to keep listening to what corporations say about their businesses. Corporate earnings continue to pour in and it’s very clear that not all businesses or industries are performing the same. The lack of broad-based, cohesive economic growth is the result of a global economy that’s still trying to balance itself out after the subprime mortgage-induced financial crisis. That bubble and its collapse continue to be far-reaching, for the world and the stock market.
There are two very significant investment risks out there and it’s my feeling that they will continue to create major headwinds for the stock market, this year and next. There is significant geopolitical risk with Iran and North Korea. These countries’ actions are naturally unpredictable. More predictable is the sovereign debt crisis in Europe and the zero economic growth it has created. Germany is the economic engine of Europe and that country is likely to outperform, but with sovereign debt in many of those countries running well over 100% of gross domestic product (GDP), the future to me seems inevitable. (See What We Can’t Forget About in the Stock Market Today.) Regardless of what happens to these countries or the euro currency, the end game is the same—little to no economic growth.
So, here is a scenario that I think has potential to transpire over the next couple of years. Europe’s sovereign debt problems will get worse, as politicians borrow more money to bail out member countries. Austerity packages will become more severe in order to aid on the government spending side and, therefore, the eurozone will be stuck with a long period of stagnating economic growth. While economic growth in the U.S. is on the cusp of accelerating, zero economic growth in Europe and declining rates of economic growth in the BRIC countries will reduce the earnings power of U.S. large-cap companies. Accordingly, it’s stagnation for the stock market as well. And this scenario doesn’t include the potential for another war.
This fundamental macro outlook is why I think the stock market is generally in the process of topping out. It may happen this year or next, but I just can’t see how corporate earnings are going to be able to accelerate in a world of very slow economic growth. That’s why I’m advocating a very conservative investment stance for stock market portfolios, with some exposure to commodities, as the Federal Reserve continues to increase the money supply.
The one thing the stock market has going for it today is that it’s not overvalued. The stock market isn’t in a bubble given the current earnings outlook. This reduces the chances of a big hit. Still, my gut tells me it’s time to become extra cautious, even though we should get more good news for a while.