Economy Still Expanding But Pessimism Proliferates

By Gus Krafve

September 7th, 2010

The latest quarterly Gross Domestic Product (GDP) numbers showed the US economy grew 1.6% in the second quarter, and many leading economists are looking for third and fourth quarter GDP to show positive growth of around 2.0%. These GDP numbers are important to watch as there has been speculation by some that the economy will sink back into a recession. A recession is defined as two consecutive quarters of negative GDP growth.

In addition to continued GDP growth, the second quarter earnings results from the nations 500 largest corporations were solid. On average, 75% of these corporations reported better than expected results, posting earnings growth of 21%! Despite these better-than-expected earnings reports which provided a boost to stocks in late July and early August, fears of a double-dip recession dominated the news flow and stocks moved lower. By contrast, these recession worries continued to propel the bull market in bonds. The year-to-date performance numbers as of August 31 for the major market indices are as follows:

§ S&P 500 -4.62%

§ S&P MidCap +0.24%

§ S&P SmallCap 600 -2.46%

§ Dow JonesInd. Avg. -3.96%

§ NASDAQ Comp. -6.84%

§ EAFE (Foreign Developed) -5.62%

§ Long-Term Treasuries +20.60%

§ Barclay’s High Yield Bonds +8.27%

§ Barclay’s Aggregate Bond +7.83%

§ Gold +13.91%

§ CRB Commodity Index +2.54%

§ U.S. Dollar Index +6.69%

It appears that investors have become a bit too negative on equities. A recent survey of individual investors from the American Association of Individual Investors shows just 20.7% of investors are bullish, with bearish investors at 49.5%. This is the lowest reading of bullish investors since the market bottom in March 2009. This indicator has a good track record of calling short-term market bottoms.

From a valuation standpoint, stocks are undervalued relative to long-term historical averages. It should also be noted the dividend yield on the S&P 500 is 2.10% vs. the 10-year Treasury yield of 2.60%. While we are not pounding the table to buy equities here, we do see value in areas of the stock market. If we do avoid a double-dip recession as the majority of economists are predicting, the remainder of the year will likely be good for equities.