Although the third quarter was unusually volatile, stocks did post gains, with the S&P 500 advancing 1.5 per cent and the Dow and Nasdaq each climbing around 3.5 per cent over the three months ended September 30.
A closer look at the numbers shows that large-cap stocks dramatically outperformed small caps and that growth outperformed value. Although stocks have registered sizeable gains so far this year, the advances have not been broadly based. The S&P 500 is up around 10per cent for the year but 40 per cent of the stocks within the index are down on a year-to-date basis.
In general, domestically-oriented areas of the market and those that are more closely associated with housing have experienced the worst performance while globally-oriented segments have outperformed. From a sector perspective, the best-performing industries so far this year have been the energy and materials sectors (both of which are highly global in nature) followed by the industrials, technology and telecommunications sectors.
Third-quarter earnings will begin to be reported soon and consensus expectations are for earnings growth levels to be in the low to mid single digits, a range we believe to be reasonable. As we have been saying for some time, however, fourth-quarter and 2008 expectations continue to be high (in excess of 10 per cent). Such growth levels imply that profit margins will be improving and, given our view that economic growth is likely to remain at a below-trend pace for at least the next few quarters, we believe such a scenario is unlikely. As a result, we expect to see earnings disappointments unless expectations come down to more reasonable levels.
In terms of the economy, housing continues to disappoint and retail sales figures have been sagging. The employment picture has held up reasonably well. However, while companies are not slashing payrolls, job creation and capital spending plans have slowed. In our opinion, the Federal Reserve will remain focused on propping up economic growth rather than letting inflation be its guide. This, we believe, implies a continued bias toward easing monetary policy. While Fed easing does not guarantee that the economy will avoid a recession, it does reduce the odds.
Bob Doll is Vice-chairman and global chief investment officer of equities at BlackRock