Tags: US | Of | Mutual | Interest | Recovery | Outlook

Money Managers: Slow Economy May End Stock Rally

Friday, 10 Jun 2011 07:12 AM

 

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The stock market comeback has proceeded at a rapid clip for more than two years. Yet the economic recovery has been frustratingly slow.

Now a spate of disappointing economic news is interrupting the market rally. It has money managers questioning whether the market can pull out of reverse and again leave the sputtering economy in its dust. If it does, credit the same factor that's driven stocks up 89 percent since their bottom in March 2009: record corporate profits.

It's a concern that will be top-of-mind at the annual Morningstar Investment Conference. The nearly 1,700 financial planners and fund managers in Chicago this week face a more complicated picture about where to put their clients' money.

It's hard to find any clear choices two years after the recession's official end in June 2009, with 9.1 percent unemployment, falling housing prices and weak consumer spending.

Stocks have fallen five weeks in a row, and appear headed toward a sixth. The Standard & Poor's 500 index is down 6 percent since the end of April. Many financial analysts think this slump is more serious than the market's other pauses in the past two-plus years.

Chuck de Lardemelle, who co-manages a pair of stock-and-bond funds, IVA Global and IVA International, recently trimmed the stock holdings in his two funds to around 68 percent.

His chief concern: The recoveries in the economy and the market may be unsustainable unless consumers feel confident enough to spend more freely. Their spending is crucial because it drives about two-thirds of the economy.

"People aren't interested in expanding the house, or buying a new car, because they're in bad shape," de Lardemelle says.

Yet corporate profits remain at record levels, due in part to expense cuts made during the recession. That's the main reason de Lardemelle thinks stocks might continue their comeback, despite the challenges consumers face.

"It's the golden age of corporate profits," he says.

These indicators show the different paths the economy and the market have taken — and why fund managers are so concerned:

THE ECONOMY

• The economy is recovering at a slower pace than it has following past recessions. The nation's gross domestic product — the economy's total output of goods and services — grew 3 percent in the first 12 months of this recovery. That was about half the average first-year growth of 6.2 percent following recessions since 1949, according to Standard & Poor's Equity Research. The growth rate continued to lag the historic average in the just-completed second year of the recovery, and is predicted to do so again in the third.

• Unemployment is off its highs, but it's still high. The unemployment rate was 9.1 percent last month, compared with 9.5 percent when the recession ended. That's a 4 percent decline in the rate, over two years. Coming out of previous recessions, improvement in the jobless rate has typically been far more rapid — 14 percent on average at this stage of a recovery, according to Moody's Analytics.

• Wages are only creeping higher. Hourly compensation is up 3.3 percent since the recession ended, according to Moody's. That's about one-third of the average 9.8 percent rise at this stage of a recovery. If wages aren't rising fast enough, consumers can't help the economy.

• The housing recovery remains elusive. A report last week found home prices in big metro areas have sunk to their lowest since 2002. Since the bubble burst in 2006, prices have fallen more than they did during the Great Depression.

THE STOCK MARKET

• Stocks have had a much stronger comeback. The S&P 500 is up 45 percent from the end of the recession.

That's far ahead of the average 24 percent gain historically posted at this stage of a recovery, according to Moody's.

But there's a caveat, one that market pros are well aware of. If historic patterns hold up, any market gain in the third year of this recovery should be modest. The average gain has been 4.9 percent, according to S&P. 

• Companies are earning record profits. Wall Street analysts expect full-year operating profits among the S&P 500 to rise nearly 18 percent this year, according to S&P Equity Research. That would make 2011 a record year. In 2012, another record is forecast, with a projected 14 percent rise in earnings. But, another caveat: Heavy equipment makers like Caterpillar and Cummins and even consumer products maker Procter & Gamble are generating an increasingly larger share of their earnings abroad, where emerging markets are growing more steadily.

Stocks still look cheap. The S&P 500's price-earnings ratio — a measure that shows investors how much they're paying for a dollar in earnings — is modest by historical standards. The P/E, based on operating earnings for the last 12 months, is 15.5 — below the median of 18.1 since 1988, according to S&P. The market is even cheaper, with a P/E of 13.7, based on earnings projections for this year.

Brian Peery, a manager at Hennessy Funds, points to such data in arguing that the bull market isn't at an end. He expects stock returns to average around 8 percent per year over the next three to five years. Double-digit gains aren't likely, given the rough patch the economy is in.

A key short-term challenge is this month's wind-down of a $600 billion bond-buying program by the Federal Reserve known as quantitative easing. It's one of a series of stimulus measures the government took to promote investment in riskier assets like stocks.

Then there's the deficit, which has de Lardemelle worried because investors are likely to grow increasingly pessimistic about the government's ability to meet its obligations. They may demand higher yields, raising the government's borrowing costs to further hamper the economy.

"Their answer has been, `Let's print money, and hope the consumer comes back,'" de Lardemelle says of U.S. policymakers. "The consumer won't be back anytime soon."

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