BlackRock's Bob Doll Expects U.S. Equities to ''Grind Higher'' in 2008'S Second Half, with Help of Global Growth, Stronger Earnings, Moderating Inflation

June 30, 2008 9:00 AM EDT

NEW YORK--(BUSINESS WIRE)--

Though the U.S. economy continues to face risks, the sense of "crisis" that was prevalent earlier in the year seems to have faded, and stock prices should "grind higher," albeit with continued volatility, as 2008's second half proceeds, according to Robert C. Doll, Vice Chairman and Global Chief Investment Officer of Equities at BlackRock, Inc. (NYSE: BLK).

Doll and BlackRock's Global Equity portfolio management group believe that although a number of potential risks remain, the longer term outlook for stocks, while rocky, is generally positive.

"Stocks hit an important low in mid-March, and although they moved higher throughout much of April and May, they have suffered a recent setback in the face of higher oil prices, worries about inflation, ongoing credit issues and a still weak economy," Doll said in his annual mid-year update and outlook for the economy and financial markets. "Despite all of the negative sentiment currently dominating markets, we believe a backdrop of still decent global growth, accommodative monetary and fiscal policies in the United States, strength in the non-financial corporate sectors, an improving earnings environment and moderating inflationary pressures should provide the basis for further gains.

"At the beginning of the year, we advised investors to remain cautiously optimistic - and the advice still holds," Doll said. "We remain in a lower return/higher volatility environment, which means that when it comes to equity investment, a focus on quality and careful security selection will continue to be all-important."

Doll believes that although the current economic slowdown is likely to persist, we are probably past the worst of the "crisis" phase. "Consumers remain under pressure and businesses are likely to stay defensive, but monetary and fiscal authorities are determined to keep policy stimulative and to seek additional ways to ease the credit and housing crunch," he said.

U.S. GDP growth will remain "mired" in a 0% to 2% range for some time, Doll said, and the U.S. economy will continue to avoid recession. "We do not believe that the U.S. economy is headed for recession," he said. "Recessions typically occur when the excesses of an economic expansion receive a sudden jolt. The problem with the recession argument this time is that, outside of the credit market, excesses in the U.S. - such as an excessive buildup in inventories - have largely been absent."

Worst of Credit Crisis Now "Behind Us"

Credit conditions have improved over the past few months, but problems persist in several areas including the mortgage, leveraged loans and auction rate markets, and many financial firms remain under pressure, facing credit downgrades, shrinking earnings, continued balance sheet de-levering and the possibility of additional write downs.

"It would be premature to suggest that the credit crunch is behind us," said Doll. "Nevertheless, we do believe that the worst of the crisis is behind us. The massive rate cuts by the Federal Reserve, combined with the central bank's more creative actions - such as opening the discount window directly to securities dealers - have gone a long way to easing credit conditions. Investors are slowly becoming more risk tolerant and opportunities are emerging in some distressed areas of the market."

Inflation Likely to Ease in Coming Months

Inflation levels in the U.S. are currently above the Federal Reserve's comfort level, Doll noted, a fact that the Fed acknowledged when it recently signaled a likely end to the current interest rate cutting cycle. "The main question now is whether the slowdown in economic activity will be sufficient to ease cyclical inflation pressures and bring inflation back inside the Fed's comfort zone," he said.

"While it seems clear that higher food and energy prices are putting upward pressure on inflationary levels, in our view, inflation is likely to ease somewhat over the balance of 2008," Doll said. "While headline inflation rates have been high, core inflation remains reasonably well contained, and we expect inflationary pressures in the U.S. to diminish in the months ahead, particularly since the credit squeeze and housing bust are both deflationary forces, and the economy continues to operate below potential."

Fed Will Probably Stand Pat On Rates

Despite fears that exceptionally high energy prices will eventually cause core inflation to rise, Doll expects the Fed to maintain the Fed funds target rate at 2.00% for the foreseeable future, given the headwinds currently facing the economy.

"The Fed has indicated that it sees the risks to growth remaining on the downside, but sees the risks to inflation turning to the upside. As a result, and barring some major shock, we think the FOMC will likely be reluctant to ease the fed funds target rate further this year," Doll said. "Although the market is pricing in the possibility of multiple 25 basis point hikes by the Fed by the end of the year, we do not believe the Fed will deliver these hikes as quickly as the markets expect given the pessimistic outlooks for consumer spending and housing as well as forecasts pointing to a continued sluggish U.S. economy."

Environment Favors Large Cap, High Quality, Growth Stocks

A focus on larger capitalization, higher quality stocks and growth styles will continue to make sense in an environment of weaker economic and earnings growth, Doll said. "As a specific area of focus, we would point to U.S. multinationals - companies that derive a significant percentage of their revenues from overseas operations - as an attractive investment opportunity, as these companies currently offer good growth and high quality, and are selling at reasonable prices," he said.

Doll favors the information technology, health care and energy sectors but counseled continued caution regarding financials. "These have been particularly hard hit this year, and we're not convinced that we have yet seen the bottom for this industry," he said.

Going forward, the U.S. equity market may continue to perform better than most other developed markets, Doll said. "Thus far, the U.S. market has weathered the downturn relatively well," he said. "We expect U.S. stocks to continue to outperform in the current environment, since the U.S. is generally a more defensive market."

At the same time, Doll encouraged investors to complement their U.S. holdings with faster-growing international markets, and to take a close look at emerging markets in particular. "Emerging markets have been growing twice as fast as their domestic counterparts, and today account for roughly one-third of global gross domestic product," he said.

Update on "10 Predictions" for 2008

In his mid-year update and outlook, Doll also revisited his annual "10 Predictions" on the markets and the economy, which were first made in January.

"At the halfway point for the year, most of our predictions remain on track," he said. "Global growth has clearly slowed, earnings have declined sharply and the Fed has cut rates drastically. Some of our predictions are looking a little more dicey, most notably our call that oil prices will end the year lower than where they started and our prediction that stocks will reach a new all-time high in 2008.

"The year still has six months to go, however, and if 2008 has taught us anything it is that market movements can be sudden and drastic in this environment," Doll said.

    Here is Doll's mid-year commentary on his "10 Predictions."

    1. World growth dips below trend for the first time since 2002.

The global economy has clearly weakened in the first half of the year. The U.S. economy has been leading the way on the downside, but other developed markets have also been slowing. European growth has declined since mid last year, but it has yet to break clearly below the long term trend of around 2%. Japanese growth has also slowed sharply, but the Japanese economy remains stronger than that of the U.S. Importantly, the emerging market experience has been very different. Emerging market exports to the developed world (particularly the U.S.) have clearly weakened, but trade flows between emerging markets have held up. To a large extent, this decoupling between developed and emerging markets can be attributed both to emerging economies being less affected by the credit crunch, and also to the fact that many emerging markets are commodity exporters rather than commodity importers.

2. The U.S. narrowly escapes an economic recession, but experiences a profits recession.

Our overall view is that while the data continue to point to a fragile U.S. economy that is facing some downside risks, it is nonetheless still growing. The housing market remains a source of significant weakness, with housing starts, building permits and new and existing home sales all declining in recent readings. Consumer confidence also has continued to weaken and the labor market has remained under pressure. There also are some silver linings in the economic picture, however. Manufacturing remains resilient and exports remain an important source of strength. The nonfinancial corporate sector also has continued to perform well. As such, we do not believe that the U.S. economy is headed for recession. From a corporate earnings standpoint, we believe that the second quarter will mark the fourth and last of negative year-over-year comparisons. A turnaround in the earnings environment would help provide an important tailwind for the markets.

3. The fed funds rate falls to 3.5% or lower as Treasury bond yields rise.

All told, the Fed cut the fed funds rate by 225 basis points in the first half of this year to leave the rate at 2.0% by the end of the second quarter. Longer-term yields have traded in a highly volatile fashion over the first couple of quarters. Treasury yields fell sharply during the height of the credit crisis, but have since moved noticeably higher over the last couple of months as the inflation outlook has become more worrisome. As the second quarter winds down, the yield on the 10-year Treasury has climbed back to where it began the year at 4.03%.

4. The dollar rises against the euro, but falls against developing market currencies.

The dollar weakened sharply early in the year as the U.S. economy slowed and as the Fed cut interest rates aggressively. The greenback has been trading in a sideways fashion over the last couple of months, although it has appears to be in a bottoming process rather than entering into a renewed uptrend. From a valuation perspective, we continue to believe that the dollar is oversold (particularly versus the euro), and may enjoy a rally against the euro in the months to come.

5. Stocks achieve a new all-time high in 2008 as price/earnings ratios improve.

Early in the second quarter, stocks moved off their lows from mid March, but in recent weeks the markets have had trouble gaining footing in the face of higher oil prices, worries about inflation, ongoing credit issues and a still weak economy. While it remains to be seen whether prices can climb enough from this point to reach a new high, our outlook for the markets remains a cautiously optimistic one. The outlook for nonfinancial sector profits is stable, and the weak dollar and relatively firm demand abroad is helping to strengthen the overseas earnings of U.S. companies. The corporate sector's heightened efforts to streamline labor costs and improve productivity in this environment are also a positive for profitability. In sum, we believe the longer-term outlook for stocks remains rocky, but is generally positive.

6. Large cap and growth outperform small cap and value.

Since the beginning of the year, we have been advocating that investors focus on higher quality investments, given slow levels of economic growth and weakening earnings. This approach would translate into a focus on large cap and growth styles. Growth styles have weathered the downturn in equity markets better than value has, and growth has outperformed on a year-to-date basis. Although large caps outperformed in the first quarter, to date smaller cap stocks have slightly outperformed their large-cap counterparts, but we remain convinced that large caps are a more attractive option in the prevailing environment.

7. Developing economies and equity markets outperform developed ones yet again.

Emerging markets, particularly in developing Asia, have been doing reasonably well in terms of economic growth. From a markets perspective, emerging markets have posted some mixed performance. China has experienced a noticeable downturn, but many Latin American markets (such as Brazil and Mexico) have continued to post strong performance.

8. Despite rising above $100 per barrel, oil prices end the year lower than where they started.

High oil prices have become one of the dominant market stories over the past couple of months as prices have hit records in excess of $140 per barrel. While there is some degree of speculative buying being built into current prices, supply/demand dynamics remain the key determinant of long-term pricing. Despite a widespread belief that the U.S. economic slowdown would exert downward pressure on demand, global demand for oil and other energy commodities remains strong. It will remain extremely difficult for supply of energy sources to keep up (much less surpass) these demand levels. We continue to believe that oil is due for a short-term correction, but energy prices will likely remain at elevated levels over the long-term.

9. Information technology, healthcare and energy outperform utilities, financials and consumer discretionary.

Although there are some outliers, this prediction is on track, primarily because energy has been one of the strongest-performing sectors of the market while financials have lagged significantly. Altogether, a basket of the IT, healthcare and energy sectors have outperformed a basket of the utilities, financials and consumer discretionary sectors.

10. Democrats capture the White House and increase their lead in the Senate, House and governors' mansions for the first time since 1992.

The outlook for Republicans this Fall continues to look grim. In what many are interpreting as a sign of things to come, Democrats have increased their majority in the House in a series of three special elections, and even some leaders in the Republican party are talking about the likelihood for additional losses in GOP seats in Congress this Fall. The race between Senators Barack Obama and John McCain is just beginning to take shape, but the backdrop of an unpopular war and a struggling economy, combined with Obama's impressive fundraising and organizational abilities, seems to give him the edge as well.

What's An Investor to Do?

In addition to his oft-repeated advice to investors to continue working closely with their financial professional to ensure that their investment portfolios are designed to best meet their long-term goals, Doll offered the following general investment guidelines for the remainder of 2008:

    --  Increase weightings to U.S. large caps: The environment of
        uncertainty and subpar economic growth is likely to persist,
        meaning that we suggest overweighting large-cap and
        high-quality stocks, with an orientation toward growth. As we
        have been saying for some time, a specific area of the market
        we like is U.S. multinationals, as these companies currently
        offer strong growth, high quality and are selling at
        reasonable prices.

    --  Complement U.S. holdings with faster-growing international
        markets: Not only does international investing offer
        diversification benefits, but we believe some non-U.S. markets
        look especially attractive given stronger levels of domestic
        economic growth. We also continue to have a positive long-term
        view towards selected emerging markets, most notably Latin
        America.

    --  Consider commodities as a long-term investment: We believe
        that a cautious approach toward commodities is warranted in
        the near term, as oil and other hard commodities may be
        overdue for some sort of cyclical downturn given their current
        lofty prices. However, long term, the fundamental secular case
        for commodities remains sound.

    --  Keep your focus: In the face of ongoing market volatility, we
        would encourage investors to remain focused on the long term,
        ride out any potential storms, look for buying opportunities
        and, above all, rely on the basic tenets of staying fully
        invested and well diversified.

The opinions expressed are those of Bob Doll as of June 27, and are subject to change. There is no guarantee that the forecasts made will come to pass. This material does not constitute investment advice and is not intended as an endorsement of any specific investment. Investment involves risk. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Past performance is no guarantee of future results. Information and opinions are derived from proprietary and nonproprietary sources.

PM Disclaimer

Individual portfolio managers for BlackRock may have opinions and/or make investment decisions that may, in certain respects, not be consistent with the information contained in this report.

Commodities Disclaimer:

Investments in commodities and the natural resources industries can be significantly affected by events relating to those industries, such as variations in the commodities markets, weather, disease, embargoes, international, political and economic developments, the success of exploration projects, tax and other government regulations, as well as other factors.

About BlackRock

BlackRock is one of the world's largest publicly traded investment management firms. At March 31, 2008, BlackRock's AUM was $1.364 trillion. The firm manages assets on behalf of institutions and individuals worldwide through a variety of equity, fixed income, cash management and alternative investment products. In addition, a growing number of institutional investors use BlackRock Solutions(R) investment system, risk management and financial advisory services. Headquartered in New York City, as of March 31, 2008, the firm has approximately 5,600 employees in 19 countries and a major presence in key global markets, including the U.S., Europe, Asia, Australia and the Middle East. For additional information, please visit the Company's website at www.blackrock.com.

(C)2008 BlackRock, Inc. All Rights Reserved.

Source: BlackRock, Inc.

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