Black Rock - Investment Commentary
Last week was a difficult one for equity markets as the correction that began several weeks ago continued. For the week, the Dow Jones Industrial Average fell 1.7% to 8,147, the S&P 500 Index declined 1.8% to 879 and the Nasdaq Composite lost 2.3% to close at 1,756. All market sectors were down, with the more cyclical areas of the market (basic materials, energy and industrials) falling the most and the more defensive areas (healthcare, utilities and consumer staples) falling the least. Following last week’s declines, markets are now at their lowest levels since April.
The rally that began in March allowed equities to appreciate by roughly 40%, so it should not come as too much of a surprise to see stocks pause. At their levels in March, stocks were pricing in a probability of a depression, and now we believe they are reflecting the reality of a recession. Policymakers around the world have engaged in widespread stimulus measures, which we believe have helped forestall a wider financial crisis. Whether these measures will translate into a more lasting and sustainable recovery remains to be seen. There are a number of factors that will need to be overcome, including anemic levels of consumer spending and a banking system that is still not functioning normally. On balance, we believe that although a number of risks remain, we should see a recovery unfold over the next several months.
After three months of a nearly uninterrupted rally, stocks appear to have entered a consolidation phase. Equity markets have seen their gains trimmed, mostly as a result of profit taking and portfolio rebalancing, and not from a change in the economic outlook. The recent setback in stocks (which has caused a correction ofabout 8% over the last four weeks) has the possibility of sparking some renewed bearishness among investors. There are many who were skeptical of the rally in the first place and there have also been many investors who have remained on the sidelines. To be sure, there are downside risks to the market, one of which can be found in the earnings landscape. Earnings expectations have been raised significantly over the past several months, and meeting those expectations could prove difficult in the current environment, which has the potential to result in disappointments.
In our opinion, however, the cyclical bull market that began in March has further to run. We do not believe that stocks have fully discounted the possibility of an economic recovery, which means that more upside to the stock market should be possible. As a result, we expect stock prices will be higher by the end of the yearthan where they are today. Our downside target for stocks remains between 800 and 850 for the S&P, and we believe this range represents an attractive entry point for those investors looking to put cash to work.
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