By Bob Doll
Last week was another tough one for the markets, with the Dow Jones Industrial Average falling 1.0% to 10,067, the S&P 500 Index declining 1.6% to 1,074 and the Nasdaq Composite dropping 2.6% to 2,147. As of the end of last week, stocks were down roughly 6.5% from their highs in mid-January. Along with the recent decline in equity prices, we have also seen some strengthening of the US dollar in recentweeks, as well as a fall in commodities prices.

The economic highlight of last week was the announcement that fourth-quarter US gross domestic product (GDP) rose by 5.7%, with strength coming from inventories, consumer spending, increased trade and capital expenditures. As this data suggests, the broad US and global economies remain in recovery mode. There are some lingering areas of weakness, including employment, the US housing market and domestic demand in Europe and Japan. On balance, however, we believe the recovery should continue and, as we have been saying for some time, we expect to soon see increases in US employment levels.

The Federal Reserve also met last week and, to no one’s surprise, kept the Fed Funds target rate on hold. There was little change to the language that accompanied the Fed’s decision, except for an acknowledgement that the economy has continued to improve. The Fed is in the process of preparing for a gradual exit from its current easy monetary policy, but we believe the central bank will need to see better evidence of improvements in housing, employment and bank lending before it starts tightening.

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Fourth quarter earnings have been coming in at a rapid clip, and the news has been extremely good. To date, 77% of companies have reported, with nearly half exceeding expectations and only 14% reporting disappointments. Notably, many companies are also reporting increases in revenues, meaning earnings improvements have not been based solely on cost-cutting measures. The strongest performers have been in the technology and consumer discretionary sectors, with the laggards being
materials, consumer staples and financials. One negative aspect to the earnings landscape is that analysts are beginning to dial back expectations for future earnings after several quarters of upward revisions.

We continue to believe that the long-term backdrop for stocks remains positive, but the corrective action we have seen over the past couple of weeks may not be over. As we discussed last week, the uncertainty over the Obama Administration’s bank regulation plans has been depressing investor sentiment, and China’s policy tightening has many concerned as well. It is, of course, impossible to determine in advance exactly how long a correction could last. We would point out, however, that the current weakness (with stocks down around 6.5%) is roughly in line with the 5% to 8% declines we saw periodically last year as stocks climbed 60% from their March 2009 lows through year-end. From our perspective, we think it is likely that while the current correction may not yet be over, neither is the cyclical bull market.

Bob Doll is ViceChairman and Global Chief Investment Officer of Fundamental Equities at BlackRock®, a premier provider of global investment management, risk management and advisory services