End of the Line or More Track to Ride?

By Lynn Reaser

Stocks have recently sped along, raising concerns that the train might run out of track.  Trading volumes have been light with large investors pulling back.  Valuations also have grown relatively rich, with questions emerging that prices have moved too high relative to future earnings potential.  Is the equity market’s recovery over or at least a short-term correction in store?

A temporary pullback in prices is certainly in order but is unlikely to take place at this time.  Why?  It is earnings release season and first quarter profits promise to be healthy.  Earnings per share for the S&P 500 corporate group are likely to be up 20-25% from their year-ago level.  Although careful attention to costs and productivity gains will give further support to profit margins, look for revenue gains to also climb some 7-10%.

Backed by strong demand from China and other emerging markets, expect particularly good sales gains for energy and materials firms, while robust demand from corporations throughout the world boosts revenues for the technology sector.  On the profits side, anticipate that financials will lead the train with a tripling of earnings on a narrowing of loan-related losses.

Stock fundamentals are positive.  Jitters about a Greek default have subsided as European governments have blinked and agreed to a bailout if necessary.  Meanwhile, a “goldilocks” scenario for the U.S. economy has emerged for the near-term.  Consumers have started to spend again and factories have cranked up production.  Inflation remains benign and the Federal Reserve shows no inclination of launching a climb in interest rates.  The Treasury is even cooperating.  Although deficit financing will be enormous this year, near-term funding requirements may be pared back from earlier expectations with economic growth helping tax revenue flows and early repayment of funds borrowed under the Troubled Asset Relief Program (TARP.)

After the end of the first quarter earnings season, do not be surprised to see stocks pull back with profit taking some air out of the market.  However, the fundamentals of solid economic growth this year suggest that the market upswing will still have more track to ride in 2010.


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