As long as the perception is that we're headed for a soft-landing, stocks will continue to perform well. If and when that changes, watch out.
- From: bromselick@xxxxxxx
- Date: 30 Aug 2006 16:39:26 -0700
By Chet Currier
Aug. 29 (Bloomberg) -- If investors can't stop chattering about the
chances for a ``soft landing'' in the U.S. economy, they have good
reason.
The phrase conjures up instant memories of some of the best years of
the roaring 1980s-'90s bull market for stocks and bonds.
According to my Bloomberg, the Standard & Poor's 500 Index climbed at a
25 percent annual rate in 1985-86, and at almost a 30 percent-per-year
pace in 1995-96, as U.S. economic growth slowed without lapsing into a
recession.
Those were lavish gains even by the extraordinary standards of the '80s
and '90s, when the S&P 500 rose at an 18 percent annual clip over the
full 20-year stretch.
In both those two-year periods, as now, the Federal Reserve had spent
the preceding months raising short-term interest rates to restrain
inflation. Economic growth, which set a torrid 7.2 percent pace in
1984, slowed to 4.1 percent in 1985 and 3.5 percent in 1986. From 4
percent in 1994, growth in the inflation- adjusted gross domestic
product tailed off to 2.5 percent in 1995 and 3.7 percent in 1996.
So the record suggests more big payoffs might be in store if the
Federal Reserve and other policy makers can pull off a similar feat
now.
That, of course, is no trifling ``if.'' A long list of perils threatens
to inflict all sorts of trouble as the economy slows in 2006 and 2007
in response to two years of rate increases by the Fed.
Menacing Mixture
``Three of the most common traits leading to recessions historically
are all flashing warning signals,'' says Liz Ann Sonders, chief
investment strategist at Charles Schwab & Co., in a recent Web site
commentary. She cites ``an inverted yield curve, an oil-price shock,
and a severe real-estate crunch.'' An inverted yield curve occurs when
longer-term interest rates are lower than shorter-term ones.
Yet strong hopes persist that a slowdown can be achieved without actual
declines in economic output. The most recent average forecast among
more than 60 economists in a monthly Bloomberg survey calls for
inflation-adjusted growth in the U.S. gross domestic product to hold at
2.7 percent or 2.8 percent through the second quarter.
``We continue to maintain that the economy is unlikely to enter into a
recession,'' says Bob Doll, president and chief investment officer at
Merrill Lynch Investment Managers in Plainsboro, New Jersey. ``Assuming
we are able to avoid the risk of a hard economic landing, we expect
that bond and stock prices will both beat cash over the next 12
months.''
Shrinking P/Es
Between here and there in stocks, Doll adds, ``continued turbulence is
likely as the economy slows and earnings expectations decline.''
By one simple gauge, price/earnings ratios, investors have already gone
to some lengths to brace themselves. The P/E of the S&P 500, at about
17 times the most recent 12 months' earnings, is half its peak four
years ago.
In the especially hard-hit housing sector, P/E ratios have gone much
lower than that. The stocks of homebuilders KB Home, D.R. Horton Inc.,
Toll Brothers Inc. and Pulte Homes Inc. trade at miserly multiples of
3.9 to 5.3.
Over the past year through the end of last week, the Alpine U.S. Real
Estate Equity Fund, a $295 million mutual fund that at last word had
about half its assets in homebuilding stocks, has lost 20 percent, and
the $163 million Fidelity Select Construction and Housing Portfolio has
declined 7.5 percent.
Hunkering Down
It remains to be seen whether this is all or even most of the
punishment investors in housing stocks are going to suffer. But it
attests that whatever bad news is yet to come on housing won't be
catching those investors completely by surprise.
If a big-as-life recession is in the cards for the economy as a whole,
markets will surely feel more pain. If nothing more than a moderate
economic slowdown happens, on the other hand, investors could have some
pleasant surprises in store.
So the outlook may come down to a very simple calculation: Soft
landing, good news for stocks; recession, more tough sledding ahead.
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To contact the writer of this column: Chet Currier in Los Angeles
ccurrier@xxxxxxxxxxxxx .
Last Updated: August 29, 2006 00:02 EDT
Chet Currier is a Bloomberg News columnist. His opinions are his own.
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