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IAS  
#1 Posted : Friday, June 1, 2012 2:52:18 AM(UTC)
IAS

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The U.S. stock market turned choppy in April and remained that way into May despite a generally solid first quarter “earnings season.” Many factors influence stock prices in the short run, but corporate earnings are the most important factor over the long term.

Continued near-recessionary conditions in Europe and slowing growth in China reminded investors that the global economy isn’t as healthy as we’d like. At recent count, 11 of the 17 countries using the euro are in recession. Germany is holding its own, but its economy is highly dependent on exports, particularly to its European neighbors. European industrial production declined again in March and a measure of European manufacturing points to further contraction in April.

Recent European elections suggest a rejection of budget austerity. Greek voters largely shunned their centrist parties in favor of more radical candidates. Certain aid funds to Greece were withheld as the European Stabilization Mechanism awaits further signs of adherence to agreed-upon spending cuts and tax increases. Greece and the rest of Europe appear to be at a standoff as to the conditions of Greece’s continued use of the euro currency and its membership in the European Union. A continued tough stand by the rest of Europe may be necessary in order to make an example of Greece, lest Italy and Spain expect a bailout. Growth in China has moderated a bit, but still remains quite strong at about 8%. Measures of its factory sector point to continued growth.

Back home, the U.S. economy appears to be maintaining its trajectory of moderate growth. First quarter Gross Domestic Product (GDP) grew at an annualized rate of 2.2%. Growth was aided by higher inventories, meaning that companies may have overproduced in the quarter. This has the potential to sap strength from coming quarters. Underlying economic growth appears to be in the 1.5%-2.0% range.

Similarly, the employment picture remains modest. The number of new jobs declined for the second straight month to 115,000. This is fewer than half the number of jobs created just a few months ago. We’ve seen this movie—signs of economic strength that can’t be sustained—before and it’s getting old. One bright spot is that weekly first-time jobless claims have come down after a brief spike.

U.S. manufacturing remains surprisingly strong despite global economic sluggishness. One of our favorite indicators, the Purchasing Managers Index from the Institute for Supply Management, points to a pickup in April. New orders and exports were both up sharply.

Data suggests that U.S. stocks remain significantly under-owned by investors. We believe there is significant potential when investors become confident enough to invest once again. The Federal Reserve’s commitment to keep short-term interest rates near zero through late 2014 encourages investors to look at equities due to the paltry opportunities in fixed income securities. The economy continues to expand at a steady, if underwhelming, pace. We believe this supports our typical, cautiously optimistic stance toward the stock market.

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