Coming off what may very well be the worst economic calamity since the Great Depression or at the very least since the recession of the early 1980s, economic conditions should prove to be much better in 2010.
Unemployment will likely stay elevated in 2010, although dropping from the current level of about 10 percent to a level around 9-9.5 percent. In fact, we expect unemployment to remain elevated at least through 2013, and do not expect it to drop below 6 percent until 2014 at the earliest. While this may sound like a very long period of time for unemployment to remain so high, if one looks back to the previous period of such high unemployment, after the recession of 1981-1982 it took six years for employment to drop back to that level.
As far as growth in the economy goes, we believe the high level of unemployment, combined with chastened consumers and businesses that are spending less and de-levering their balance sheets, will make it difficult for GDP to grow more than marginally over the next couple of years. Further, with debt less available due to banks needing to replenish their tattered balance sheets, non-traditional lenders having less lending capacity or hewing to more stringent credit requirements, and an implosion of the asset-backed lending markets, there is just less debt capital available to drive GDP growth to any degree. Further, with investors requiring higher returns on equity capital, raising equity for investment is also more difficult, or when it is available is more expensive.
As such, the bounce back from the recent negative GDP numbers is likely to take some time. We are unlikely to get back to the GDP levels reached at the highs of several years ago until at the soonest early 2012 in our view.
What does this mean to the stock markets for 2010? Well, following a year in which an initial large decline in the markets was followed by an upswing off the lows so large and quick that it is virtually unrivaled in our stock market’s history, we anticipate we could get a pause in 2010. The increase in stock prices we have seen, combined with the compression of earnings that resulted from the recession, have made the price of equities not exactly inexpensive at current levels.
Investors, in our opinion, have been looking beyond the current earnings environment and towards the eventual turnaround in business conditions.
However, this optimism among investors means that equities currently look somewhat expensive on near-term earnings. The S&P 500 is currently trading at approximately 15 times next year’s (2010) projected earnings. This is not particularly expensive, but not cheap either. The S&P 500 has historically traded at 13-18 times earnings during periods of low interest rates and inflation, which places the current valuation in the mid-point of this range. However, we note that this compares to nearly 19 times 2009 projected earnings, a relatively expensive number. As such, analysts are projecting significant growth in earnings for 2010.
While we believe such growth is probable, should earnings come in below expectations, investors could be disappointed, resulting in a drop in share prices. Further, we note that dividend yields are below normal due to the large number of dividend cuts and eliminations, which reduces the cash flow for investors. With these issues in mind, at this point we believe higher stock prices are likely for 2010, but gains are likely to be muted as earnings catch up to the currently optimistic expectations and the economy remains weak.
As far as expectations for Louisville and Northern Kentucky go, unemployment is currently slightly above the national average, and we anticipate a recovery will be slow in coming, much like the remainder of the country. Louisville does have the advantage of having a large healthcare industry, which should add to employment growth, but offsetting that to some degree will be the area’s industrial exposure, which is much more subject to the economic malaise and could remain depressed until consumer spending picks up. Further, with relatively high taxes and government spending as well as a high level of regulation in the state, we believe the environment for small business, which is typically the driving force behind job and wealth creation, is likely to remain difficult.
With unemployment likely to stay relatively high for an extended period, like the rest of the country, we expect economic growth is likely to be slow but measured, potentially falling slightly behind the country as a whole. However, like the rest of the country, we will eventually turn around, and come back out of the malaise we have been experiencing.
John Roberts is director of research
for Louisville-based Hilliard Lyons
wealth management services.