The first quarter of 2010 was a roller-coaster ride for the market. Yet the S&P 500 rose 4.8% in the quarter, marking its best first-quarter performance since 1998. As we begin the second quarter, the Federal Reserve has stopped purchasing mortgage-backed securities, which could strip away some of the tailwinds for the stock market's gains. We also face the handoff from government stimulus-led growth to organic economic growth. So where does the market go from here?
Despite the transition, and questions surrounding the sustainability of our economic recovery, Bob Froehlich, senior managing director of The Hartford Mutual Funds at Hartford Financial
"Most people are backing themselves into a corner thinking that you can't sustain it because they're only looking at government stimulus," he said in an interview. "They might miss a really great market move, because I think the sustainability can actually be as good as the recovery."
Froehlich said the market is transitioning from being driven by government stimulus, low interest rates, and "manufactured earnings," to one propelled by "real earnings" from revenue growth. For the past couple of quarters, companies "manufactured" earnings through cost-cutting, downsizing, and productivity, as opposed to organic growth or sales.
Now, higher business spending will drive an increase in sales growth, Froehlich said. That, in turn, should fuel the stock market. "Corporations are flush with cash," he said. "Shareholders are not going to let them sit on that cash."
First-quarter earnings season, which unofficially kicks off with Alcoa April 12, should be the first sign of top-line growth for corporations.
"[I'm] extremely optimistic about first-quarter earnings," Froehlich said. "I think they'll be much better than fourth-quarter earnings. Then sequentially when we get to second-quarter earnings, I think they'll be better than the first quarter."
Aside from business spending, what will replace the government's stimulus package and low interest rates? Froehlich finds optimism in the continuation of a massive inventory rebuild, and consumers who are down, but not out. "Looking at the numbers from high-end retailer Tiffany
He also believes that the global economy will surprise on the high side, with growth somewhere greater than 4%. That bodes well for multinationals firms like Coke
More predictions from Froehlich
*Interest rates move higher, but not until the fourth quarter of this year.
"There's no way the Fed could consider moving interest rates with the Congressional election around the corner and unemployment above 10%. Politically, it just doesn't add up to me." Froehlich said that gives the stock market a free pass until after the election, which means we'll see lots of liquidity in the market through November.
*The worst of the job losses are behind us, but the unemployment number could peak back above 10% from 9.7%, because of the way the government calculates the number.
People who have grown disenchanted and given up on looking for work were not accounted for in the unemployment number. When they see the positive job growth and start looking again, they'll start getting counted, causing the number to go up, even though nothing has changed.
*We'll never see unemployment at 5% again.
Full employment will settle around 8% unemployment, according to Froehlich. In part, that's because corporate America's layoffs during the downturn were an overreaction, fueled by fears that the world would to end. The other part is structural. "I don't think we realized how much our payrolls were bloated," he said. "The fact of the matter is every single day we're able to do things better, faster, cheaper, more efficient, which means we don't need as many people."
*GDP growth will have to rely on something more than job growth.
With the new normal for unemployment at 8%, not 5%, Froehlich said emerging markets and exports will lead our economy, as opposed to jobs.
The monster hiding in the closet
The one potential pitfall for the market, according to Froehlich, is rising oil prices. "I think oil is telling us how strong the global economy really is," he said. "But we're going to be at a crucial point, because there's something psychological about triple digit oil prices and we're nearing that."
In fact, Froehlich says he doesn't believe the current recession began with the subprime mortgage crisis. Instead, he thinks it began when oil hit triple digits for the first time. "I think it crushed business and consumer confidence," he said.
If we do see oil hit the triple digits, Froehlich said the market will get much tougher. "I wouldn't say all bets are off. But I would say we would transition from a market that would have a bias to the high side, to a market where you better be a really, really good stock picker because not everything is going up."
What do investors do now?
Froehlich says he thinks the story of this market will be captured through the following sectors: energy, financial services, technology, and global health care.
"If there's one way to play higher oil prices, it's the energy sector," he said. "I think we'll continue to see more companies spend money on technology than they will on employees as we come out of this recession. Lastly, the contrarian play that I would throw in would be health care from a global basis. So I'd be looking for global health-care players, not the domestic-driven ones."
Do you agree with Froehlich? Where do you think the market is headed? Weigh in below!
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Fool contributor Jennifer Schonberger does not own shares of any of the companies mentioned in this article. You can follow her on Twitter. Coca-Cola is a Motley Fool Inside Value choice. Coca-Cola is a Motley Fool Income Investor selection.
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