Strategists Like Stocks, Despite the Economy

If you have any exposure at all to the US economy, whether you run a corporation or you are raising money for the school PTA, you have no doubt noticed a certain reservation among people to spend, invest, or give their money. August proved a tough month for the economy. Confidence crushers such as the debt ceiling debate, the unprecedented downgrade of US Treasuries from AAA to AA+ by Standard & Poor’s, a plunging stock market, an earthquake strong enough to suggest attack for many in DC and NY, and an east coast hurricane that literally quieted the “city that never sleeps” all fueled a growing sense of pessimism. 

The Conference Board reported earlier this week that confidence plummeted 14.7 points in August to 44.5, the lowest reading since April 2009. Consumer expectations for employment, business conditions and income all fell. The expectations index, at 51.9, is also at its lowest level since April 2009. Mild positives in the report were gains in plans to buy cars and major appliances, but purchase plans for homes fell sharply.

The National Association of Realtors said that pending home sales declined 1.3% in July after a 2.4% increase the prior month. However the good news was that signings to buy new homes increased 14.4% in July. And home prices may be stabilizing. The Case-Shiller 10—city index showed that home price declines ended June were unchanged for a second month (three month average). On a year ago basis, prices are down 3.9%.

The stalwart US manufacturing sector continues to buttress the economy. Perhaps the data will indicate slowing in the coming weeks, but for now, the lonely champion of the US economy resists the malaise. The ISM manufacturing composite index edged only three tenths lower in August to a reading of 50.6. The reading above 50 indicates monthly expansion in general activity, but it is relatively slow. Job creation was blamed for holding this month’s number down. Today the government announced that the unemployment rate remained steady at 9.1%.

However, once the economy turns, job creation may improve. It appears that companies have squeezed about as much productivity from their current lean workforces as they may be able to get. Nonfarm productivity fell an annualized 0.7%, compared to the original estimate of a 0.3% dip and a 0.6% decrease in the first quarter. The drop is also attributed to a revised more sluggish rise in output of 1.3%. But businesses may have to pay more for workers. The report showed that unit labor costs increased by a revised 3.3% in the second quarter, compared to an initial estimate of 2.2%.

August was a tough month for stock indexes which fell about 16% as measured by the S&P 500 index. The 9% recovery since then has seemingly done little to quell fears of further declines. The State Street Investor Confidence index fell from 102.5 in July to 89.6 by August’s end. A reading below 100 indicates demand for safety relative to risk. The report attributes the flight to safety to diminished growth expectations, the US downgrade, and continued sovereign troubles in Europe.

Strategists Expect 16% Rally by Year End

Bloomberg says that “Wall Street has never been [surer] that the Standard & Poor’s 500 Index will rally in 2011, even after speculation the US economy is heading for a recession prompted the biggest plunge since the bull market began.” The Bloomberg survey of 13 chief bank strategists forecast the index rise to an average of 1,401 (16%) by year’s end. That estimate did not budge in August.

Strategists say that earnings growth will fuel the gains they expect. The survey reveals that S&P 500 profit will rise 18% in 2011 and 14% in 2012. With almost all of the S&P’s 500 companies reporting for the second quarter earnings season, more than 75% of them exceeded their earnings estimates, with total income topping projections by 5.2%.

Bloomberg says that investors are paying less for equities than they have during every recession since Ronald Reagan was president amid growing concern that the economy is on the edge of another recession. With the 13% drop in the S&P 500 in the past five weeks, the price-to-earnings ratio has fallen to 12.9, 3.5% less than the average multiple during the 10 contractions since 1949 and a level last reached in 1982.

If another recession is ahead, stocks may stay cheap for a while longer. But if corporations continue to grow their earnings or even maintain them at current levels, stock prices will almost certainly rise. If you are a long term investor, take heart, all the cash sloshing around in this economy will eventually find a home where it will be treated best; and historically that’s common stocks.

Have a happy Labor Day Weekend. Our office will be closed on Monday in observance of the holiday.