The economy might be lackluster and there is a risk of another recession, but the stock market is fairly priced and the outlook for corporate earnings continues to be solid. The gyrations of the stock market are based on fear—fear of a future without growth. Small-cap companies are going to have a more difficult time generating earnings growth over the coming quarters because their operations are more closely tied to the domestic economy. Large-cap companies, such as those in the Dow Jones Industrial Average and many within the S&P 500 Index, are going to keep growing their earnings because of their international operations and a weaker dollar that translates into a better bottom line.
The economy no doubt has a lot of structural problems to overcome and it will take a few more years to do so. The fiscal situation has to be addressed and a measured, reasonable plan needs to be put in place to deal with deficits and debt. Excess inventory in the housing market needs to be taken up for homeowners to feel more secure about the valuation of their main assets. And, finally, the employment situation has to improve in order for incomes and consumer spending to rise. These are big hurdles to overcome and it will take more time to do so.
From the investor’s perspective, the fundamental backdrop of the economy is something we have to live with. Corporations continue to be running very lean operations and, with interest rates low and cash balances high, large companies can grow their earnings even if the domestic economy is stuck in an age of austerity.
Right now, the most attractive new investment opportunities in the stock market are large-cap, higher-dividend-paying companies with significant international operations. At the speculative end, gold continues to be the best play.
I think it’s fair to expect the broader market to continue gyrating for the rest of the third quarter. Technically, the main stock market averages aren’t looking good, but these significant pullbacks have happened before and stocks recovered. As you know, the stock market is all about betting on the future. Right now, the market is digesting an uncertain future with the expectation of weaker economic growth (or a possible recession). Beyond this expectation is a fundamental backdrop that looks pretty good from the investors’ perspective, as policymakers begin to address their finances and the housing market has more time to balance itself out.
Corporate balance sheets are in very good condition at this time. Insiders are buying their own shares. An economic analysis of the current data suggests that a period of slow to breakeven growth is likely in the bottom half of this year. In the not-too-distant future, the stock market will look beyond this expectation and investors will be buyers.