Outlook for the Stock Market

Extracted from Morningstar's September 2011 Quarter-End Insight

Uncertainty and equity market volatility will continue into the fourth quarter as European states struggle to balance the economic imperatives of their polities with their commitment to currency union. If uncertainty regarding the viability of the European Union deepens or if a determined and credible solution to the eurozone's structural weaknesses is not found soon, the impacts to global trade will likely be material over the short- to medium-term.

Companies in the U.S. are generally well-positioned to survive a downturn, having greatly improved the condition of their balance sheets and taken steps to increase profitability since the 2008-2009 downturn.

The European debt and fiscal crises have continued and deepened over the past three months to the extent that more and more observers are beginning to openly question the political viability of the European Union. The Greeks long for the ability to devalue their way to export prosperity that an independent Drachma would grant them while chafing at EU-imposed austerity measures; German voters grumble about picking up the tab for Greek profligacy.

In the U.S., what had long been considered a procedural matter of voting an increase in the debt ceiling limit to fund spending already approved by Congress turned into a full-blown political battle. The showdown ended up nearly halting government services and prompted the first agency downgrade of U.S. sovereign debt in history. The ugly political wrangling, combined with high levels of unemployment and an overall tepid recovery contributed to a drop in consumer confidence to 2009 crisis levels and set the ball rolling on what is feeling more and more like an equity bear market.

The one bright spot amid the gloom and concern has been falling energy prices. Gasoline prices have fallen for three consecutive months.

The two greatest contributors to U.S. GDP growth since the 2008-2009 downturn were the consumer and exports. We believe that consumer spending is likely to come under pressure for the prospects of higher taxes and lingering high unemployment levels, and also fear that a breakup or partial breakup of the eurozone or a dragging on of uncertainty over viable solutions to its structural problems could well crimp U.S. exports.

While these may sound like gloomy pronouncements, we must also note that thanks to steps taken during the recent downturn and an increased economic exposure to more rapidly expanding developing economies, many U.S. companies find themselves in enviable positions in terms of profitability and balance sheet strength. Profit margins are running at all-time highs, and the aggregate amount of cash on U.S. corporate balance sheets amounts to over $2 trillion--a record amount.