Headwinds, still, for a tumultuous year

By Daniel Bases

NEW YORK (BestGrowthStock) – No one said 2010 was going to be an easy year in the markets and for economic growth worldwide.

And it hasn’t been.

The gruesome U.S. stock market performance in May, the worst in 15 months, is the latest evidence of a tumultuous year that started with cautious optimism for investors trying to navigate between signs of economic recovery, crisis and policy reforms.

Europe’s expanding government debt crisis has knocked the euro below $1.20 against the dollar, its lowest level in more than four years, and called into question the currency’s authority.

“Negative shocks, especially from the euro zone, will accelerate the pace of the euro’s downward trend, while a more stabile environment will ensure a more orderly – but still significant – decline,” BNP Paribas wrote clients on Thursday.

The euro’s drop combined with stock market plunges and the gloomy picture streaming from the ecological disaster in the Gulf of Mexico has brewed up a stinky caldron of trouble.

In that kind of environment, it’s difficult to blame investors for their skittish behavior.

Twice in May, Wall Street’s favored indicator of investor fear, the Chicago Board of Options Exchange volatility index, or VIX (.VIX: ) for short, spiked twice above 40 before quickly retreating, indicating high levels of uncertainty.

The saw-toothed pattern of rallies melting into sell-offs highlights the lack of conviction across the globe.

Fund flow data from EPFR Global showed cash continues to pour into fixed-income investments to the detriment of equities, while money is still being pulled from safe-haven money market funds, offering yet another contradictory trend.

Top investment analysts will sort through the conflicting data at the mid-year Reuters Investment Outlook Summit June 7-10, to give their best guesses as to how the second half of the year pans out after a volatile six months of 2010.

WHERE TO HIDE?

Not even the robust economies of the emerging markets have been spared. Stocks there are down even more than the debt-strapped developed markets, while safe havens such as gold and U.S. Treasuries remain in fashion.

That makes picking investments even more critical.

“Within global equities, we continue to underweight Europe and other developed equity markets and overweight U.S. small and mid-caps, the emerging markets and two commodity-sensitive markets: Canada and Australia,” Morgan Stanley Smith Barney wrote to clients in May.

That said, the latest Reuters poll of 47 leading global institutional investors showed an average mixed portfolio held 52.3 percent in equities versus 52.8 in April.

Equity analysts are expecting global earnings growth of 32 percent over the next 12 months, according to Thomson Reuters StarMine data.

For U.S. companies, earnings growth over the next 12 months is seen up 36 percent.

The sectors expected to lead the earnings growth are materials and financial companies. But that outlook comes with a health warning, given they are operating from a low base for comparison. These sectors were severely curtailed by the financial crisis.

For the U.S. economy, the world’s largest, booming corporate profits have been a bullish signal for economic activity, Barclays Capital notes.

The firm said that only six times since 1950 have corporate profits risen at a 30 percent or faster year-on-year pace.

“Each of these periods has been followed by real GDP growth of at least 3 percent in the following year and by job growth of 1.9 percent or better,” Barclays wrote.

CAVEATS ALL AROUND

The road ahead isn’t likely to be any smoother than the first half of 2010.

On the positive side, the U.S. economy is showing signs of life, with employment growing in May for fifth month in a row. While first-quarter gross domestic product was revised slightly lower to 3 percent from 3.2 percent, a recovery still appeared solid, in spite of Europe’s credit crisis.

But there are caveats, both economic and political.

New U.S. financial market regulations are soon to be signed into law 20 months after the collapse of Lehman Brothers. One likely result is lower profits for Wall Street banks, brokers and investment managers.

Europe’s austerity measures, an attempt to avoid a Greek-style public debt meltdown, are likely to slow the pace of economic growth for years to come, creating a disincentive for investors to put cash to work in the euro zone.

The $1 trillion bailout package of European Union and International Monetary Fund cash isn’t seen as a solution but rather a Band-Aid.

Global manufacturing data, while still showing expansion, did register a slowdown in May, and governments are not rushing to remove economic stimulus. That means the risk remains for corporate borrowers to be crowded out.

Interest rates globally are expected to remain low. In the United States, chances are that the near-zero benchmark Federal Reserve overnight rate will hold through 2010 because of the tentative nature of the recovery.

Stock Investing

(Editing by Padraic Cassidy)

Headwinds, still, for a tumultuous year