The market has been struggling to make up its mind on the strength or weakness of the economy. One group of analysts is calling for a down turn. Another faction sees the recovery continuing and gathering strength. A third band looks for the economy to “muddle” along neither achieving a robust growth rate, nor falling back into a recession. What does this mean for investors and what should we do now?
From my perspective, we remain in the “muddle” through model with signs of strength in the economy created by the continued expansion of the emerging markets, especially China, India, and Brazil. Much of the remaining part of the United States Economy will remain mired in high unemployment and a weak housing sector.
Investors worry about the outlook for the U.S. economy and the European sovereign debt question. This causes the market to trade in volatile moves with most stocks moving in sync with the overall market. There has been little room for quality companies to separate themselves from the general market trading action. The major news of the day moves the market. As long as you were on the right side of the market trend, you did well. Selecting specific stocks that might outperform the market worked as long as you were in high beta stocks and on the right side of the trend.
Five factors will dominate the economy over the next 12 months:
1. Uncertainty about the future improves as the anti-business tone in Washington diminishes. Fewer political initiatives as the Congress of the United States swings from the left leaning democrats to one with more conservative and right wing elements. With the prospect of a stalemate in congress, investors can expect less change from the government reducing the uncertainity that has plagued companies and investors.
The financial sector will be the greatest benefactor, though they still face declining or flat loan demand as companies and consumers reduce their debt load.
2. Emerging markets drive global growth. Any sector or company that derives the bulk of their business from exporting capital goods, commodities and certain higher end consumer goods should see their revenues and earnings appreciate nicely.
Capital goods companies that export like Boeing, Caterpillar (CAT) and Deere (DE) will continue to experience robust revenue and earnings expansion. Their upstream suppliers will also participate including the likes of Nucor, Titanium Metals (TIE), Precision Cast Parts (PCP) and Trimble Navigation (TRMB).
Higher end consumer goods companies with a growing presence in China, India, and Brazil will see demand for their products drive up revenues. Coach (COH), Williams Sonoma (WSM), and Apple (APPL) fit here nicely.
Productivity continues to enhance companies’ bottom lines. Most providers of the software and hardware necessary to change the way a company does business in position to grow revenues and profits. Cisco (CSCO), EMC (EMC), Oracle (ORCL) and Hewlett Packard (HPQ) come to mind.
3. Employment will diverge. Those with the skills in demand (software engineering, engineering in general, proven sales experience, and healthcare are examples) will see many job opportunities. On the other hand, anyone with lower level skills or who only has worked in the home construction industry will continue to suffer slow to negative job growth.
To maintain employment equilibrium the economy must add 100,000 to 125,000 new jobs a month. So far, we have not even reached that level. When we do, there still are the more than 9 million unemployed and 17 million underemployed people looking for work. Many of these people lack the necessary skills and reduction to find well-paying jobs. The muddle through economy does not hold very good prospects for them.
4. Leading labor’s problems is a weak housing market. The overbuilding and large numbers of foreclosures are major contributors to housings woes. Supply remains excess and prices keep falling as the market tries to find the right balance of available homes and at what price.
Fire sale prices encourage new homeowners and investors to wait for the best deal rather than buy one of the lower priced homes. As long as this attitude persists, the single-family housing market will remain in the doldrums. I do not expect this picture to improve any time soon.
5. The Federal Reserve will remain supportive. The Fed will keep short term rates near zero for another year. They might add to the available money supply by buying additional treasuries goring their enormous balance sheet even further.
The fed is more worried about deflation showing up as the economy stumbles along. An accommodative Fed will help keep the economy from plunging back into a deflationary recession. However, they cannot correct the other structural problems that will keep the economy in slow growth mode.
As the economy muddles along, the fundamentals of the companies that continue to do well will change the game for them. Look for quality in earnings growth and good valuations before jumping in. Since the market will continue to oscillate from highs to lows within a channel, there will be good opportunities to pick up bargains if you are patient. This remains a stock pickers market, so take advantage of it. The light you see at the end of the tunnel is a very slow moving train. There is no need to hurry to get on board.
