2008 Market Volatility
January 25, 2008
Montag & Caldwell’s winners last year have been under pressure in 2008, but we remain confident in our client’s holdings.
The U.S. Economy is very close to stall speed and is on the cusp of a recession. If we do have a recession we would expect it to be mild due to the fact that there are not many excesses in the non-financial, non-housing areas of the U.S. economy. These areas have low inventories, have not hired excessively, and have kept capital spending in check. In addition, the Federal Reserve has finally acted in an attempt to protect economic growth and restore financial market stability. We think they are still behind the curve, but expect them to remain accommodative. Finally, a healthy global economy should contribute to U. S. economic growth.
Regardless of whether we have a recession, the outlook for corporate profit growth for the next few quarters is modest. Stock market volatility should persist due to ongoing credit market turmoil, a more challenging corporate profit environment, and fears of a U.S. recession. There is no dispute that business conditions are weakening, corporate profits are contracting, and more disappointing economic news is likely on the way. In addition, the credit market turmoil could be open ended. The credit cycle has just turned and so problem areas could pop up beyond sub-prime. We think investors have been as worried about the credit market situation as they have been about a recession. Of course they are interrelated fears.
A recession is a close call, but the markets are already down almost 20% from the highs and are discounting much of the economic risk. Profit estimates for 2008 are probably too high but downside risks should be limited due to the Fed, healthy global economy, potential fiscal stimulus, and lack of excesses. Even if you expect S&P earnings to be flat for 2008, that implies a P/E of 15.5x and an earnings yield of 6.4% versus the 3.5% of the 10 year - so valuations are discounting some weakness in earnings.
We view the increased volatility as part of the bigger picture rotation into large cap growth. Major rotations are typically accompanied by increased market volatility.
Bottom line: The high-quality large-cap growth companies in our portfolios continue to have compelling valuation and earnings growth characteristics in view of the challenging U.S. earnings environment that is developing. Given moderating but still healthy global growth, the relative earnings momentum of our holdings should stand out significantly and our clients should be positioned to benefit.
