Harlan Levy's  Instablog

Sam Stovall is Standard & Poor’s’ chief investment strategist, as well as author of the book The Seven Rules of Wall Street, and “Stovall’s Sector Watch,” a page on
www.businessweek.com
 
Harlan Levy is a business reporter and columnist at the Connecticut daily newspaper the Journal Inquirer.
 
H.L.: How significant is Dubai’s debt default – asking creditors for a six-month stay on repayment of $60 billion in debts?
 
S.S.: It’s significant from a sentiment perspective, because it reminds investors who went too far out on the risk curve once again that all is not well, that the global debt situation is still precarious.
 
H.L.: What effect will Dubai have on the stock market?
 
S.S.: It’s already had an impact on equity markets on the holiday-shortened Friday trading day and will likely have added to weekend angst.
 
When you think of the size of the loan itself — $60 billion — a little more than in the Madoff scandal — it certainly is a lot of money from one source, but not a lot when you put the global market in perspective. So I believe investors will be paying close attention to Abu Dhabi’s willingness to back Dubai’s debt.
 
The real concern is whether this is just one of many foreign debt crises that could emerge in the coming year. It’s the uncertainty that is the problem. We know how much the Dubai loan is for, and we know the exposure that lending institutions have. What we don’t know is how many other Dubais are out there. It’s all too recent a reminder of the 2008 debt crisis.
 
H.L.: Will Dubai’s problem spark a stronger dollar as a safe haven?
 
S.S.: It already has, and it could be a catalyst of at least a short-term counter-trend rally in the direction of the dollar. We still believe that the dollar will weaken into 2011, but this financial concern as well as future mini-financial fires will probably cause the U.S. dollar to experience periodic pockets of strength.
 
H.L.: How fragile do you think our economy – the recovery -- is at this point?
 
S.S.: I think the recovery is still precarious, that the economy has been supported by massive stimulus and liquidity injections, that many analysts are worried will be undermined when the U.S. government begins to remove such stimulus and by the end of this year will begin raising short-term interest rates.
 
We see the U.S. economy growing at only 3 percent a year between now and 2013, but we only see U.S. consumers increasing their spending by only 1.8 percent per year.
 
We also see unemployment averaging above 10 percent in 2010 and above 9 percent in 2011. We see this economy growing very slowly and steadily, but we don’t think you will spell “recovery” with a capital “V,” nor do we expect a double dip.
 
H.L.: This week we’ve got a hefty bunch of economic reports: equipment purchasing, October construction spending, the Institute for Supply Management’s November manufacturing index, October pending home sales, November auto sales, job cuts, weekly initial jobless claims, third-quarter productivity, and finally, the big ones, nonfarm jobs and the jobless rate. What will they tell us?
 
S.S.: When looking at our economic estimates coming out this week compared to their prior periods we think a majority will show a downward revision.
 
We see productivity coming in closer to 8.5 percent rather than the 9.5 percent. We expect to see that Tuesday’s manufacturing and construction data will likely be lower than the prior period, as will Thursday’s productivity report.
 
The two main economic numbers this week that may show an improvement are the I.S.M. non-manufacturing index which is expected to show a very slight increase, and on Friday, we believe that non-farm payrolls will be off 125,000 in November, versus the 190,000 we saw in October. We also think the unemployment rate will hold at 10.2 percent.
 
One report coming out on Friday that will be in the shadow of the payroll report is factory orders, which is expected to rise at a slower rate than in the prior period.
 
What these reports tell you is that the third quarter was the strongest one coming out of this recession and that the 2.8 percent preliminary third-quarter growth will probably slow to a 1.7 percent annualized growth rate in the fourth quarter. What’s more, we expect economic growth to be a shade below 2 percent in all of 2010.
 
H.L.: This decade is about to come to a close. How do you see it matching up with prior decades?
 
S.S.: I would describe this decade as a dismal one. On a cumulative total return basis, including dividends for the entire decade investors in the S&P 500 have lost 16 percent, versus a gain of 433 percent in the 1990s. They were the good old days. On a relative basis the 1970s and the 1930s could also be called the “good old days,” because the S&P 500 at least posted a positive total return in each one of those decades.
 
Digging a little bit deeper, we find that in this decade five of the 10 sectors in the S&P 500 fell on a price-only basis, led by a 67 percent decline in telecommunications, a 56 percent decline in technology, and 39 percent fall in financials. Energy was the leader, gaining 103 percent, followed by consumer staples and materials gains of 33 percent and 23 percent, respectively.
 
H.L.: Where may investors find good value in the new decade?
 
S.S.: Frequently the loser in one decade becomes a winner in the following decade and vice versa. If we sort out this financial crisis early in the next decade, then investors might want to become reacquainted with cyclical stocks in general and the techs, financials, and consumer discretionary stocks in particular.
 
H.L.: What about energy?
 
S.S.: Good question. In the 1970s energy, the best performing sector, up 295 percent versus 17 percent for the S&P 500, excluding dividends, ended up being the worst performing sector in the 1980s. In the 1990s, technology was the best performing sector, up more than 1,100 percent, yet it was among the two worst performing sectors in this decade. So, frequently, worst becomes first, and vice versa. But of course, past performance is no guarantee of future results.

Scott Wren is Senior Equity Strategist for Wells Fargo Advisors in St. Louis. He appears regularly on CNBC, Bloomberg TV, The Nightly Business Report and in articles in the Wall Street Journal and the Financial Times.

Harlan Levy is a business reporter and columnist at the Connecticut daily newspaper the Journal Inquirer.

H.L.: Are investors losing confidence in the stock market’s upward trend, expecting a pullback?

S.W.: I think a lot of investors have been expecting a pullback since June or July, and that’s one of the reasons why we’ve been able to push higher.

A lot of people, both professional and retail investors, have missed a lot of this move that we’ve seen off the March lows and have been waiting and hoping for a pullback. We have not had a lot of people chasing the market, and that typically allows the market to run a little higher, especially in the face of better economic news and much better than expected earnings two quarters in a row.

Investors have coming to the realization that earnings estimates for this year, 2010, and 2011 are probably too low. We’ve been telling our clients that our estimates for the last month or so are starting to look too low for all of those years, and our estimates are higher than consensus estimates. Now we’re telling our clients that we’re likely to raise our earnings estimates, and we’re likely to raise our targets as a result of that.

H.L.: We’re at the start of the seasonal low in stock trading volume. So, should investors focus more on price action than the declining volume as an indicator of the market’s direction?

S.W.: Volume has been declining, and volume has not been a good indicator for a while, particularly for most of this rally. So in the near term we are likely to get some pullback and consolidation.

If we have a couple of months of that, that would make some sense. It would create some opportunities for those who missed this run-up, because what clients need to be doing is looking out a couple of years and making sure of their positions for that time frame. They should not be concerned about what’s happening over the next couple of months.
Investors need to make sure that they have overweight exposures to those sectors that are most sensitive to an economic recovery both here in the United States and globally.

H.L.: What are those sectors?

S.W.: Sectors that we like are industrials and the materials sector. We also think clients should have an even-weight exposure in the consumer discretionary sector.

They need to be underweight in the more defensive sectors that are less sensitive to the economic cycle, like health care, utilities, and consumer staples.

H.L.: Is the credit crunch getting worse?

S.W.: I think that the demand for credit is very low. We all know that it’s tougher to get credit, but what a lot of people don’t realize is the demand for credit is unusually low for this point in the cycle.

I don’t know if it’s necessarily a credit crunch, but companies and individuals are hesitant to borrow. Smaller companies are particularly hesitant to borrow, because they’re very uncertain what is coming as far as the tax structure and any other governmental regulation that they’ll have to deal with.

H.L.: But a lot of people think that the banks are really holding back on loans and investing in securities instead to make a pile of cash. Is that wrong?

S.W.: Credit standards were way too loose and needed to be tightened up, and banks and other financial institutions are just trying to improve their balance sheets and prepare for a better economy ahead.

H.L.: The jobless numbers don’t seem to be getting better fast enough for investors. What’s your take?

S.W.: At some point that’s going to come into play, but right now companies’ margins are expanding , and company productivity is high, so you’re going to see companies recover a lot faster than employment.
Companies are trying to squeeze as much out of every employee that they have. They’re very hesitant to add new employees.

H.L.: What do you see ahead next year?

S.W.: Next year you’re going to see more cyclical recovery and a higher stock market. A year from now, the stock market could be as much as 12 to 15 percent higher than where it is now.

H.L.: What about the dollar? It seems to be dominating the market so that when it weakens stocks surge, and when it strengthen, stocks go down.

S.W.: It wouldn’t surprise me to see the dollar rally a little bit. Everybody’s playing it for a lower dollar, and when that happens it usually doesn’t pan out that way.

H.L.: Is the housing market about to recover?

S.W.: There are a lot of people out there wanting to sell their houses who are waiting for better prices and some stability. So I think it’s going to be hard for housing prices to recover a lot over the next few years. Also, there are a lot of houses that banks own that they want to sell, so there’s a lot of supply out there. That should keep a lid on prices.

If people perceive that the housing market is stable and the prices of their homes are not going to go down a lot from here, that builds confidence and helps consumers feel a little bit better about discretionary spending. If consumers are more willing to spend money that will help the economy. We expect modest economic growth next year.

Nariman Behravesh is the chief economist at IHS Gobal Insight, the $100 million consulting company that provides economic, financial, and political analysis worldwide. He directs Global Insight's entire forecasting process and is responsible for developing the economic outlook and risk analysis for the U.S., Europe, Japan, China, and other emerging markets.

Harlan Levy is a business reporter and columnist at the Connecticut daily newspaper the Journal Inquirer.

HL: In light of last week's report that the U.S. trade deficit is widening, is the weak dollar a good thing, although more declines could lead to inflation and higher interest rates?
 
N.B.: The dollar decline has two potential effects: One, it could add to inflation, and the other is that it’s hugely popular for exports in that it makes our products much more competitive worldwide.
 
In this environment, with an unemployment rate over 10 percent and huge amounts of excess capacity, inflation is not a problem. So the potential inflationary effect of a weaker dollar is for all intents and purposes nonexistent. So the net effect now of a weak dollar is hugely positive and all on the export side.
 
Long term, it’s a little harder to tell in the sense that if the U.S. economy grows strongly, and we use up a lot of that excess capacity, you could have an inflationary effect of the weak dollar. But that’s three to four years away.
 
HL: What do last week’s initial unemployment claims number — more than 500,000, down 12,000 from the week before — and the 10.2 percent unemployment rate tell you about the economy and where it’s headed?
 
N.B.: The recovery in the jobs market always lags the recovery in the economy. These numbers are consistent with that, which is to say the unemployment rate is still rising, and the jobs claims numbers, while they’re coming down, are still in recession territory. You have to get the claims number down to the 300,000 level to be out of recession and below 300,000 for us to be out of recession in the job market as well.
 
The economy is in a modest recovery right now, so the problem here is with the economy recovering, albeit modestly, and the job market is lagging. This is a recovery that won’t feel like a recovery for a while.
 
HL: What do you think of the volatility in the stock markets?
 
N.B.: The stock market has moved to much a higher level than it was at the March bottom, but the Dow Jones Industrial Average is mostly fluctuating between 9,500 and 10,000. But investors are fairly upbeat for good reason. The good reason is that the earnings numbers and the profits numbers from companies have been pretty good. So this is not a bubble, mostly because it’s based on earnings and good profit numbers.
 
H.L.: Are the stock prices nearing at a top?
 
N.B.: Basically I think there’s not a lot of upside in terms of stock prices, because investors have pretty much factored in the good earnings story. I think 11,000 on the Dow is a long way off, at least a year away. Until then I wouldn’t expect the market to keep rising the way it has.
 
After a year I think it could easily break 11,000 on the Dow. That’s when we feel the economy will start to grow robustly. We think that in the last two or three quarters the economy will grow at a rate of 2.5 percent, and by the second half of 2010 we’ll probably get up to about 3.5 percent growth as the recovery gains momentum and that’s the point when the Dow wil rise significantly, say, over 11,000.
 
HL: What sectors look healthy to you for next year?
 
N.B.: Right now the sectors that are the most healthy and are recovering very strongly are high tech, which is doing well, healthcare, which always does well, and also information-based industries will do well. But even the lagging industries, like autos and construction will start to look pretty good as well by the end of next year.
 
HL: What do you see happening in the housing market?
 
N.B.: I would say right now the worst is behind us, but we haven’t really gotten into a meaningful recovery yet. We’re still in a shallow U-shaped pattern in terms of the cycle, but we’re still at the bottom, and a recovery hasn’t gained traction yet.
 
I think it’s early next year when we’ll start to see significant improvement in housing activity which will start to look like a recovery. Right now we’re starting to see some green shoots, so to speak, but it’s still early.
 
The reason for the hesitant recovery is that foreclosures are still a big problem, and what that’s doing is continuing to put downward pressure on home prices, and that’s a bit of a disincentive for home buyers, because they’re saying that home prices could go down some more, so there’s no harm in waiting.
 
HL: What’s happening with commodity prices, and what do you expect?
 
N.B.: Energy .commodity prices have taken off recently, but we don’t see that they’re supported by the fundamentals. We think it’s more investor activity rather than supply and demand that’s pushing up commodity prices.
 
So it’s possible we have a mini-bubble in some commodity markets, oil in particular and some of the metals markets. I would say there’s a little bit of worry that their market prices are not supported by market fundamentals.
 
HL: Are you basically optimistic about out economic future?
 
N.B.: Yes. I think the U.S. has a lot going for it. We’ve just come through a very bad episode, but one of the most positive things going on right now is productivity growth. Strong productivity growth will set the stage for a very good recovery.
 
What strong productivity growth is doing is making the corporate sector in the U.S. extremely healthy, because U.S. companies are in very, very good shape financially. It’s evident in the earnings numbers and in the amount of cash that U.S. companies now have. And they’re going to start deploying some of that cash. We’ll see it in more spending on capital goods. We’ll see it in more hiring, probably next year. We’ll see it in greater merger and acquisition activity, so this is all good news. But it all traces back to strong productivity growth.