Equities were able to retrace over half their losses early in the month to post a large but manageable loss for August (see monthly index numbers below). Momentum seems to be bullish after fears over S&P’s downgrade, and investors are left wondering if markets will continue their winning ways.
Our take is that the market will muddle through the fourth quarter up 3%-4%, ending up with a mid-single digit return for 2011.
There are several reasons for this outlook. Stocks are cheap, with forward P/Es below average. Corporate balance sheets are strong, earnings are growing, and dividend yields are attractive compared to fixed income.
The lack of competition is one of the biggest drivers of this view. With 10-year Treasury notes paying around 2.25%, there simply isn’t anywhere left to invest. And with credit spreads continuing to widen, high-yield bonds seem too scary to take the limelight away from stocks.
I don’t foresee any staggeringly brilliant legislative moves that would right the economy immediately, or new Federal Reserve policies that will cause the Dow to skyrocket. But I do see us muddling through—and that’s not such a bad thing.