2011 Market Outlook: Rebound to Expansion

The coming year should mark a transition from rebound to expansion in the economy, although the pace of stock market earnings gains should moderate somewhat.
By Bill Stone ,

By Bill Stone of PNC Wealth Management

"The trouble with our times is that the future isn't what it used to be."

-- Paul Valéry

We believe the theme of transition from rebound to expansion is appropriate for the 2011 outlook because we expect a transition year for both the economy and the financial markets. Both the financial markets and the economy have now rebounded off 2009's brutal lows. PNC projects that the U.S. economy as measured by real GDP will eclipse the previous peak set in 2007 by the end of the first quarter of 2011 and move into expansion mode.

In 2010 we correctly made the case for a V-shaped earnings rebound for

S&P 500

earnings. As part of this transition year, we expect the pace of earnings gains to moderate. Although we don't believe all the earnings leverage has been exhausted, the extremely large gains are probably over, barring a greater-than-expected acceleration in global GDP growth. At this time, we forecast 2011 S&P 500 earnings will grow in the high single digits to the low- to mid-$90s level, consistent with our mid-single-digit expectations for U.S. nominal GDP growth.

Using our version of normalized earnings and preferring to err on the conservative side, the 2011 PNC fair value range estimate for the S&P 500 will be set at 1,250-1,365, with an expected value of 1,310. The 1,310 level should provide a total return (including a dividend yield of about 2%) in the high single digits to low double digits depending on where the S&P 500 closes for 2010.

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While the high correlation between the stocks within the S&P 500 that about four months ago eclipsed even the high levels reached during the credit crisis has continued to recede, we would expect further easing in this measure as macroeconomic concerns fade over the course of 2011. This should lead to opportunities for more possible tactical changes, which would benefit active managers as the returns from individual companies and various assets differentiate themselves further.

We would expect a continued trend of rolling crises to continue to roil the markets from time to time. One needs only look to earlier 2010 concerns regarding Greece and the more recent worries about Ireland. Since it is our belief that the market occasionally will become overbought or oversold in the short term as the market overreacts to current fundamentals or concerns, it is far better in our opinion for investors to focus primarily on valuation and fundamental factors combined with their longer-term expectations and their goals and risk tolerance when making asset allocation decisions.

Our current recommended allocation attempts to balance the relative attractiveness of stocks and other risk assets, given the transition to expansion that we expect in the global economy, with the continued downside risks to our forecast. We remain vigilant in monitoring asset valuations and the factors discussed in terms of our views on economic recovery sustainability and the threats of the various rolling crises that are likely to be encountered.

Bill Stone is the Chief Investment Strategist for PNC Wealth Management and PNC Institutional Investments with over $100 billion in assets under management. He is a member of PNC's Investment Policy Committee and is responsible for defining the asset allocations and portfolio strategies used throughout the organization to advise individual and institutional investors. Stone is a cum laude and honor's program graduate of the University of Dayton with a bachelor's degree in finance. He earned a master's of business administration from the Katz Graduate School of Business at the University of Pittsburgh. In addition, he holds the Chartered Financial Analyst� designation and is a Chartered Market Technician. Stone has been quoted in many publications including The Wall Street Journal, Financial Times, Barron's, Fortune, Forbes and USA Today. He is regularly interviewed by Associated Press and Reuters. He is also regularly interviewed on CNBC and Fox Business for his market insights.

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