Return of the Great Recession? More like a soft patch, says Bob Doll

The economic recovery will continue; we do not believe that the economy will endure a double-dip recession. Growth levels should remain positive for the time being, although the pace of growth will be slower than that typically associated with recoveries.

Equity markets were mixed to down last week; the Dow Jones Industrial Average lost 0.9% to fall to 10,214, the S&P 500 Index lost 0.7% to fall to 1,072 and the Nasdaq Composite rose 0.3% to reach 2,180.

Economic data continues to point to a US economy that is struggling, but slowly recovering. One noticeable bright spot continues to be corporate earnings. The second-quarter earnings season is nearly complete and, on average, corporations have beaten expectations by an impressive 10%.

Overall, 75% of companies have reported better-than-expected results. Non-financial corporate profits have grown by approximately 40% in the second quarter compared to 2009 and revenue growth has also been impressive. As a sign that improvements in corporate earnings have been broad-based, all ten sectors of the market are showing positive gains for the first time since the second quarter of 2007.

Perhaps the most important data points regarding the strength of the economy are those regarding the employment landscape. Gains in employment are a necessary catalyst to spark a self-sustaining economic recovery. The overall trend in employment growth so far in 2010 has been positive, but gains have been small and have not been enough to lower the unemployment rate. The latest figures on this front were last week’s initial jobless claims, which increased again, reaching 500,000 for the first time since November 2009.

The continued weakness of employment data and other areas of the economy remains a concern, with many believing that the United States is in a process of sliding back into recession. This fear has held stock prices back despite strong corporate earnings. To be sure, if the United States does enter into recession again, there will be a corresponding drop in stock prices. However, even without such a scenario, there is enough prevailing uncertainty to keep investors on-edge. Consumers and investors remain uneasy, and we have seen an increase in the household savings rate, which naturally corresponds with a decrease in consumer spending levels. The corporate sector remains an important
counterbalance, with rising profit margins, low borrowing costs and healthy balance sheets.

Looking ahead, we believe that economic data will continue to be mixed and that disappointments will continue. In any case, however, we have not altered our view that the economic recovery will continue; we do not believe that the economy will endure a double-dip recession. Growth levels should remain positive for the time being, although the pace of growth will be slower than that typically associated with recoveries.

The sell-off in stock prices since mid-April is primarily a reflection of the markets’ discounting of the slower trend in economic growth. If our forecast holds true, however, and we are enduring a soft patch rather than a renewed recession, stock prices should soon stabilize. The prevailing crosscurrents are likely to mean that we will endure a prolonged stalemate for equities. As long as employment growth is sluggish and the consumer sector remains depressed, we are unlikely to see a quick rebound in equity prices. On the other hand, strong corporate profits and extremely low interest
rates have created attractive equity valuations, which should keep buyers in the marketplace.

(Bob Doll is vice chairman and chief equity strategist for fundamental equities at BlackRock)