The S&P 500 has now recovered more than 20 percent from the early March lows, but this certainly underscores the differences between Main Street and Wall Street, say the analysts at PNC.
The March employment report released last Friday was dismal at best. The payroll jobs report showed 663,000 job losses for the month and the unemployment rate increased to 8.5 percent. To put this in perspective, this is the highest unemployment rate since November 1983. It is almost certain to move higher in the coming months.
Ironically, the one ray of hope in the report was the revision on January's payroll job losses from 598,000 to 741,000. Typically, job losses show a peak at some point during the downturn and perhaps this January revision will form that peak with the still dismal numbers for February and March showing at least a positive rate of change.
The stock market shrugged off the poor jobs data on Friday and posted a slight gain for the day, which brought the week's gains in the S&P 500 above 3 percent. Make no mistake that Main Street will continue to feel the impact of the economic downturn for some time, with U.S. GDP likely to fall 5 percent in the first quarter of 2009 and the decline almost certain to continue at least through the second quarter as unemployment continues to rise.
First-quarter earnings season is set to officially begin on Tuesday. This season should again reflect the economic weakness on Main Street-year-over-year earnings on the S&P 500 are expected to fall more than 34 percent.
For the first time in this earnings recession, every single sector of the S&P 500 is expected to show a year-over-year earnings decline. Perhaps more shocking is that seven out of ten sectors are expected to post double-digit earnings declines, with only Heath Care, Consumer Staples, and Utilities expected to limit the damage to the single digits.
Again, all is not lost. Low expectations are actually a positive for the stock market as opposed to Main Street. It may indeed be getting closer to the point where expectations are so low that companies are eventually able to exceed them, despite a brutal operating environment. In many respects stocks are likely to trade more on future earnings estimates rather than current results, which is logical, because 2009 should mark the trough of corporate earnings and investors should purchase companies for their future earnings not their past.
While there are some signs of what Federal Reserve Chairman Ben Bernanke termed green shoots of Spring in the economic recovery, there are no definitive signs of recovery in either the banking crisis or the economic downturn. Some economic data (housing sales and auto sales) have turned less negative, which is certainly welcome, but some portion of this so-called recovery is due to the fact that numerically it was difficult for the data to get much worse.
It is undoubtedly very positive that mortgage rates have fallen to a sub-5 percent level, which has spurred increased mortgage applications for both new purchases and refinancing. When combined with the decline in home pricing, these factors have conspired to drive housing affordability to extremely attractive levels. We find this tonic for the epicenter of the current crisis to be very heartening.
While some global economies have also seen some similar green shoots, we continue to view the economic risk of developed international economies to exceed that of the United States-in particular the Eurozone and Japan.
Certainly there are reasons to be buoyed by the economic data becoming less bad and the prospect of better days on Main Street, but there continues to be danger of another freeze that may prolong this winter economic season.
We believe that stocks provide an attractive risk versus reward for investors with a sufficient investment holding period and ability to withstand volatility. Equity prices move in advance of improvement in the economy and earnings. Historically, stocks have advanced before there were positive signs from the economy or corporate earnings. As with any leading indicator, stocks are apt to run too far in advance of reality and may be subject to pullback if the current signs of economic recovery prove unsustainable.
There are also numerous hurdles to clear in terms of the banking crisis, with the results of the bank stress tests and success of the plan to deal with legacy assets clogging the financial system. PNC's recommended allocation calls for a baseline allocation of stocks relative to bonds; a general recommendation of an overweight to U.S. large-cap stocks and an underweight to international stocks; and a preference for high-quality stocks.
Forecasting the bottom in stocks is a fool's errand, instead we would recommend that investors focus on what is in their control and knowable - their asset allocation considering their long-term goals, risk tolerance, investment holding period, expected liabilities, and cash flows.
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