Monday, 22 June 2009

BlackRock's Bob Doll on the outlook for equities

The following is an article written by Bob Doll and published in the FT on 3rd June 2009...

A different kind of rally

It would be an understatement to say that global equity markets have been volatile in 2009.

After sinking sharply in January and February as economic data continued to worsen and as investors grew uncertain about policymakers' next steps in combating the credit crisis, global equities went on the rise in the next couple of months and now seem to have entered a period of uncertainty.

Is the recent rally for real, or merely a blip in a longer bear market? Does it represent the start of a new bull market? Will we see less volatility from here, or should we expect the roller coaster to continue?

Since the bear market began in earnest last September (with the collapse of Lehman Brothers marking an important inflection point), several global equity rallies have failed to take hold. In our opinion, however, the rally that started in March is different. That rally (which, from trough to peak, has resulted in global price advances of more than 30 per cent) is based on a combination of technically oversold conditions, aggressive global policy actions and a general sense that the global economic recession is moving past its period of greatest weakness.

The question now is whether the rally marks the end of the bear market, or if it merely represents a temporary bounce from oversold conditions. It would be premature to suggest that a new bull market has emerged or that we have seen the end of the see-saw patterns that have been in place since last autumn.

Nevertheless, we do believe there are several important differences between current conditions and the failed rally attempts that previously occurred. From a technical perspective, this rally has been marked by strong momentum and expanding volume on the upside, and diminishing momentum and volume on the downside. Additionally, lower quality and more cyclical areas of the market have been outperforming, as have emerging markets when compared with developed markets, trends that occur when more sustained recoveries begin.

The extent to which equities are able to continue to advance will depend largely on the degree to which the global economy is able to recover. On balance, our view is that the global economy is still in the midst of a severe and dangerous recession, but, importantly, the massive policy initiatives around the world have begun to bear some fruit. The dramatic interest rate cuts, spending increases, tax cuts, capital injections, bank rescues and plethora of new government programmes have all helped to combat ongoing credit-related deflation risks.

We believe the fourth quarter of 2008 and the first quarter of 2009 will mark the low points for economic growth. We expect a small gain in world economic growth by the third quarter of this year. We also expect to see modestly positive levels of growth in the United States at some point in the second half.

While investors have grown more optimistic in recent months in the face of some "less bad" economic news, it is important to remember that less bad is not the same as actual good news. As such, we believe the rally that started in early March may be running out of steam and that a resumption of the rally will require more solid evidence of an economic recovery.

At present, we believe equities are entering a correction phase, although we believe this correction will be marked more by sideways action and less by a sharp decline. We think it is extremely unlikely that prices will retreat back to their early-March levels, but we could see some modest near-term declines and believe that continued volatility is likely. Typically, such corrections result in a give-back of between one-third to one-half of recent gains (which, in the United States, would result in a short-term drop to between 800 and 850 for the S&P 500 Index).

Over the longer term, however, we expect improving economic conditions will help equities to rise, and we believe that stocks will outperform bonds and cash over the next 12 months.

The writer is vice chairman and global chief investment officer of equities at BlackRock

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