Observers now say with a high confidence level that the Great Recession of 2008 and 2009 will come to an end in the United States at some point during this quarter. In fact, the PNC Economics Department expects U.S. real GDP growth of 2.5 to 3.0 percent annualized for the third quarter of 2009.
Since this economic downturn was precipitated by a financial crisis, it is important to point out that these investors are still cautious about the economic forecast and markets as a whole. Bill Stone, PNC’s chief investment strategist, says that he expects a modest U.S. economic recovery for the second half of 2009 followed by a broadening global economic recovery throughout 2010, but added that the ride will not necessarily be smooth.
Stone sat down with Smart Business to talk about some of the challenges and opportunities in the financial market and how investors and consumers have been affected.
Why do you expect an increase in GDP?
Some tailwind is inevitable due to increased government spending from the fiscal stimulus package. But more importantly, we believe the third quarter gain will be supported by the huge inventory draw-downs of previous quarters, which allow for the resumption of industrial production. This forecast is reinforced by the July industrial production data, which were recently reported at an increase of 0.5 percent month over month — only the second positive report in the past 18 months. Industrial production was bolstered by a boost in manufacturing output thanks to a surge in motor vehicle production. Also supporting the increase is industrial production for the developed world, which seems to have stabilized, and emerging economies’ production, which is growing again.
If the domestic economic backdrop is improving, why are investors still cautious about the markets?
Questions still remain about the strength and sustainability of the recovery. Our baseline forecast for economic recovery already reflects our expectation of a relatively subpar economic recovery in the United States relative to what one would normally expect following an economic decline of the extent just experienced. As a positive, actual job losses are likely to moderate through 2009, but we expect the labor markets to remain weak for some time, with the unemployment rate peaking at just south of 10 percent in first quarter 2010. Housing prices seem to be stabilizing but are not likely to rebound rapidly given continuing foreclosures and a weak labor market. And consumer spending has continued to be anemic. We believe consumers spend based on their expectation of lifetime earnings, so a sustained recovery in spending is not likely until they become more comfortable with their future employment situation.
You also mentioned global economy recovery. Is there value in emerging market stocks?
It seems likely that emerging markets will continue their march toward closing the gap with developed economies. Emerging markets now comprise roughly 12 percent of total world market capitalization and 21 percent of market capitalization outside of the United States. The MSCI EM® (Emerging Markets) Index consists of 22 countries, with just seven comprising a significant share of the market capitalization (79 percent) as of June 30.
In such a diverse index, it becomes difficult to generalize economic and investment situations, but we do believe emerging markets are also an easily investable asset through exchange traded funds or mutual funds. Investors should expect this volatility but regard it in terms of the long-term attractiveness of the opportunities in the area.
What is the general investment outlook for the next few months?
Though it is impossible to consistently forecast the markets’ short-term movements, our view has been and remains that the markets will likely grind higher. It seems possible that they will experience more of the ‘two steps forward and one step back’ movement that has been seen in recent weeks as economic data and expectations vacillate. A number of factors support this view such as equity valuations, investor sentiment, household cash and second-quarter earning reports.
As I said previously, the economic outlook should provide a constructive backdrop for the markets. It’s critical though to be mindful that significant challenges remain — including possible further rising yields and oil prices or increased credit contraction — all of which could smother or delay the economic recovery.
Investors purchasing or owning equities currently should look to future earnings because earnings from the recent past do not support current levels. This is as it should be, because an investor should purchase a company for future earnings, not past. It does, however, mean that jitters about future economic and earnings growth will likely transmute into equity market weakness.
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E. WILLAM STONE, CFA, CMT, is chief investment strategist with PNC Wealth Management and Institutional Investments. Reach him at email@example.com or (215) 585-6051.