It's halftime for the stock market.
The first half of the year is ending with a loud thump, as the market barreled lower from its highs for the year reached in late April. Fears swirled that we might be headed back into bear market territory, as the European debt crisis roared on and as we started to see a moderation in economic data. Although we're starting to come back from the depths of the correction, we're still down 8.7% on the S&P 500 from the peak of 1,219.80 on April 26. For the year, the S&P is down slightly.
What will the second half bring? Is the correction over? Are the problems with Europe priced in, or is the market headed back into bear market territory? To find some answers, I spoke with Bob Doll, chief equity strategist and head of the US Large Cap Series equity team at the world's largest asset management firm, BlackRock
Here is an edited transcript of our conversation.
Jennifer Schonberger: From about the end of April to the beginning of June, we underwent a furious correction in the stock market, as you know. Is the correction over in your view, or is this simply a brief respite and is the market headed lower?
Bob Doll: My best guess -- and that's all these things are in the short term -- is that we are toward the end of the correction in terms of price; meaning perhaps we have seen the lows in the 1040 to 1060 zone on the S&P, where we went twice. I think there's a decent probability. But then we have more time in terms of the correction, because it's going to take time to repair some of the damage we've done, and to get clarity on some of the fundamentals that have gotten in our way.
Schonberger: So, you think we're going to be in trading range here for a bit?
Doll: I think that's what we'll do. The good news of economic and earnings recovery is buttressed by the difficulties of the European contagion questions, the political environment in the U.S., and to some degree the monetary tightening cycle that is inevitably in front of us.
Schonberger: To your point, are the problems with Europe priced in at this point?
Doll: One never knows for sure. I guess my answer is yes if the assumption -- and this is the one we're going on -- is that we will muddle through. I don't think there's some day I can call you up and say, "Jennifer, guess what? We solved Europe. Check the box." I think we will just meander and muddle, and it'll move from the first page to the second page to hopefully the eighth page of the newspaper.
Schonberger: Are you still confident in the strength of the U.S. recovery given the European debt crisis and the moderation we're seeing in recent economic data? Or do you expect a moderation in growth in the second half?
Doll: Economic cycles typically have growth slowdown periods in their recoveries, and it looks like that's what we're in. The added uncertainty is, are we in this because naturally we would have gone there, as happens every cycle, or are we going there because of contagion from the European situation? My guess is it's a little bit of both. In order to have a resumption of the market I'm looking for evidence that the economic recovery is still on track. We may not get a whole lot of confidence around that until we start seeing second-quarter earnings, which are a few weeks away.
Schonberger: Is the inventory rebuilding mostly finished at this point, or do we still have a little ways to go in that?
Doll: I think we have some more to go. Best we can tell, inventories are still pretty lean. Not that they're going to get heavy, but we think there is some more restocking to go after the massive destocking of last year.
Schonberger: And that could probably add a little bit onto GDP [gross domestic product] as well, right?
Doll: Yeah, I think it makes GDP a little stronger than what final demand is for the next few quarters.
Schonberger: We've seen some earnings warnings in the past two weeks -- for example with McDonald's
Doll: Not overly. I'm a little worried about estimates being too high for next year; but for the next couple of quarters it's all right. You cited a handful of companies, but there are also a handful that have said things are OK. I think having a few companies toward the end of the quarter that give a little bit of a yellow light is very normal. Look, are we going to have the strong earnings surprises we saw in the fourth quarter of last year and first quarter of this? It's hard to repeat that. But the earnings will be sufficient, adequate, and modestly above expectations. I think that's probably in the cards.
Schonberger: Where do you see the next big risk to our economy?
Doll: I think it's still the broad deflation risk that pokes its ugly head from time to time. I think the European problems are a manifestation of that -- that is to say we are in a slow, nominal growth world, and we all pay our bills in nominal dollars. If there aren't as many nominal dollars because inflation's very low and there are deflationary threats, that means some people can't pay their bills. I think we will have those bumps from time to time get in the way of -- we think inevitable -- global economic and earnings recovery.
Schonberger: There are concerns floating around that there could be a looming crisis in municipal bonds, given the poor fiscal health of many states. Do you see that as a possibility, or is it more of a problem rather than a crisis?
Doll: Are some municipalities in crisis mode? Absolutely. As you well know, states and local governments generally have to balance their budgets every day, so they don't have the option of just saying, "Let's wait for a brighter day." They've got to increase receipts or cut expenses by cutting services and/or cutting people.
I think the days of muni securities all moving in lockstep are behind us. You've got to do your credit research. I think there will be selected municipal areas that will really struggle, and others that do just fine. To repeat, you've got to be able to do your credit research to separate the wheat from the chaff.