Merrill Analyst Is Bearish on Second Half

Richard Bernstein says investors hopes for an economic rebound in the second half are optimistic.
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Amid mixed signals on the economic front, a few bears are starting to show their claws.

Richard Bernstein, chief U.S. strategist at Merrill Lynch, is the latest one to voice concerns, saying Monday that investors' hopes for an economic and corporate rebound in the second half are overly optimistic.

Bernstein said only four of the 10 indicators that he follows suggest that profits will be stronger than estimates, and that these indicators are based on technical factors. In the past, he noted, such technical factors haven't been followed by a recovery in corporate earnings.

The technical factors include Merrill analysts' raising profit estimates for various U.S. companies and a better performance of three of the firm's portfolios of "low-quality," or risky, companies. But fundamental indicators, such as the firm's Inflation Composite Indicator, or the gap between what companies are reporting and what analysts are expecting, are still neutral, Bernstein said.

"We continue to believe that earnings expectations for the second half of the year are too optimistic given these indicators' readings," he said. "There were several instances in the past in which our technical indicators gave positive signals, but our fundamentals did not agree. Each time, the signals of the fundamental indicators proved far more important."

Bernstein also said he finds it "astounding that investors continue to pay substantial premium valuations to take risk, and pass up the opportunity to receive compensation for relative safety," suggesting market participants are overlooking safer stocks and paying high prices on riskier investments.

He predicts profits in the second half won't be as robust as many experts believe because companies continue to face decreasing pricing power. He expects inflation to remain tame until year end.

Bernstein suggests that investors use the recent rally to sell lower-quality, or riskier, issues and continue to screen for higher-quality companies, or ones that pay dividends and have healthy balance sheets. But he warns that "such companies are a true scarcity."