What’s Next for the Global Markets?

Extracted from BlackRock Market Commentary written by Bob Doll, Peter Fisher, and Mike Trudel of BlackRock, Inc.

It would be an understatement to suggest that the past several weeks have been eventful ones. Markets have remained in a highly volatile trading pattern since early August as investors have become increasingly concerned about the European debt crisis, the weakening US economy and potential actions by policymakers designed to address these problems.

Trying to assess what all of this means for the markets and what investors should do with their portfolios can be challenging. The European debt crisis has intensified in recent weeks as the possibility of a Greek default has grown and fears have been escalating. So far, policymakers in Europe have been taking incremental actions, such as increasing bond purchases but clearly these actions have been insufficient to stem the crisis.

The divisive political backdrop in Europe has hindered aggressive action. Each country in the Eurozone has its own agenda and interests to consider and it’s far from certain that individual countries would be able to come to agreements on their own.

Ultimately, the hope is that the Europe's banking leaders will be able to accomplish what European governments have not been able to due to political constraints. The extent to which Europe’s policymakers are successful will be critically important in helping to determine the future direction of the world’s economy and financial markets.

The economic situation in the United States has clearly deteriorated over the past couple of months. The labor market has been stagnant, housing remains weak and the beleaguered US consumer is struggling. Additionally, the United States is facing its own fiscal issues.

Nevertheless, the United States remains in somewhat better shape than Europe. The data is pointing to weak growth, but growth nonetheless. On balance, the economy will continue to “muddle through” at a weak, but still positive, rate. Over the coming quarters, US growth should be slightly better than the 1% rate it reached in the first half of this year, and while that growth rate could hardly be called robust, growth on the positive side of zero still places the US economy in expansion mode.

On balance, we would peg the odds of a recession occurring in the United States over the next two to three quarters at around one-in-three. Although that figure remains uncomfortably high, it still indicates a greater chance that a recession will not happen. Should the situation in Europe deteriorate further, however, that would certainly push the odds of a US recession higher. In any case, even if a recession were to occur, it would almost certainly be shallower than the recession sparked by the 2008–2009 credit crisis.

The investing environment today is one that is dominated by uncertainty, with the Europe situation remaining dominant. These are clearly difficult times for investors, but we believe opportunities can still be found.

Stock markets have been punished by the flight-to-quality trade that has dominated the markets in recent months. Yet, corporate earnings have remained resilient thus far, which suggests equity valuations have become more attractive. The question, of course, is whether markets have reached a bottom, or whether they have further to fall.

As with the direction of the economy, the future direction of stock prices will be highly dependent on the outcomes for Europe and the US economy. As our view skews to the more optimistic side regarding these issues, we also are retaining our positive long-term outlook for stocks.

Within the United States, we see some significant opportunities in many areas of the market. Given our view that a US recession is unlikely, we find cyclical areas of the market (such as technology and energy) that have seen significant declines to be quite attractive — particularly those companies that have decent balance sheets. Additionally, we favor high-quality growth companies. Companies that have the ability to grow their earnings in a weak economy represent a particularly good opportunity; within this theme, we have a favorable view of the healthcare sector. Additionally, we continue to focus on companies with the ability to generate strong levels of free cash flow. Companies that have the ability to raise dividends, buy back stock and make new investments are well positioned.

Outside of the US, our investment themes are quite similar. There are many high-quality companies with attractive valuations and high earnings potential. In particular, we think it makes sense to focus on companies that have access to markets experiencing stronger economic growth (chiefly in emerging markets such as China). As with our preferences within the US, we are focused on companies that generate strong levels of free cash flow. Many companies around the world have robust balance sheets and the ability to return cash to shareholders through dividends, share buybacks, etc. and these companies offer some significant value, in our view.

Finally, we would point out that there are some opportunities available in European markets. Compared to US stocks, European equities have experienced much sharper declines, as these markets have already priced in an economic and financial meltdown. Certainly, this is an area of the market that must be approached cautiously, but we do see some value in select European stocks.

We know that maintaining a long-term focus during times of intense market volatility can be difficult. At times like these, we would encourage investors to remain in close contact with their financial professionals, who can help identify tactical opportunities that may be appropriate for investors’ long-term investment plans.