Wells Capital Management's Chief Investment Strategist, Jim Paulsen, has just released his exhaustive investment outlook. The complete report, which is longer than the following prefacing text, follows in a slidedeck, which you can either download or fullscreen.
by James Paulsen, Chief Investment Strategist
Wells Capital Management
Since its collapse in early August, the stock market has experienced extreme daily price volatility oscillating within a broad range. These emotional daily price swings reflect a skittish investor struggling with a dichotomy between extremely attractive relative stock market valuations and an array of escalating fears. Investor worries include a widening contagion from the European sovereign debt crisis, the potential for a hard landing among emerging world economies, uncertainty introduced by uncommon and confusing Federal Reserve policy actions, and the likelihood of yet another debt ceiling debate looming on the horizon.
While these concerns should keep daily price volatility elevated, how the stock market ultimately breaks from its recent trading range will probably be determined by whether the U.S. economy avoids recession. In the next several weeks, economic reports will either galvanize recession expectations or consensus fears will once again calm, embracing the likelyhood that the U.S. economic recovery will persevere. Should a recession become obvious, the stock market would likely suffer a further significant decline. Alternatively, investor greed may dominate the rest of this year should recession fears fade as investors act to take advantage of a valuation metric (about 11 times earnings with a sub-2 percent 10-year Treasury) which, without a recession, represents a fire sale!
A U.S. Recession?
An imminent U.S. recession is unlikely. First, the traditional economic policies which precede a recession are not evident. The U.S. does not possess an inverted yield curve, has not been subjected to significant short-term nor long-term interest rate hikes, and is not suffering from restrictive liquidity conditions or tight fiscal policies.
Second, can the U.S. suffer a recession when there is nothing to recess? Recessions often result from “excesses in need of a correction.” Since the last recession ended only two years ago and since it was so extreme, private sector players have thus far been well-behaved in the contemporary recovery. Are individuals paying up too much for houses today? Have consumers extinguished pent-up demands for durable goods? Is the savings rate too low (the savings rate has been hovering about a 20-year high since the recovery began)? Are household debt burdens oppressive (the household debt service burden is in its lowest quartile since 1980 and no higher today than it was in 1985)? Have banks been aggressively overextending loans? Has anyone been borrowing too much lately? Are companies overstaffed? Overinventoried? Have businesses over invested in the last couple years? Has the Fed tightened too aggressively? Have bond vigilantes raised bond yields too much? Too much fiscal tightening lately? Is anyone lacking for liquidity? Are households overexposed to the stock market today? Is optimism over the top? It is hard to see why the U.S. would experience a recession when almost nothing requires a “correction.” Indeed, before the next U.S. recession, the answer to at least some of these questions will likely be yes!
Third, despite a significant economic slowdown since early this year (annualized real GDP growth rose only 0.7 percent in the first half and real GDI growth rose by only 2 percent), the economy is already showing some signs of bouncing. After flattening earlier this year, real personal consumption is on pace to rise more than 1.5 percent in the third quarter, weekly retail chain store sales have remained relatively robust, and the annualized U.S. auto sales rate has risen by more than 14 percent since June to 13.1 million, helped by Japan bouncing back from its tsunami. Weekly unemployment insurance claims remain in the low 400,000 range, reported private sector ADP employment gains have averaged 100,000 in the last two months and layoff announcements as recorded by the Challenger Job Cuts Index have remained subdued. (more)
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