Peter Anderson

RCM Capital Management

Outlook

We are optimistic about the market’s prospects for 2009. We are forecasting a 10% rise for the year for equities, with all of those gains occurring in the second half of the year. We are also positive about 2010, simply because a more robust economy should boost corporate profits significantly higher.

We estimate a decline in real Gross Domestic Product (GDP) in the first quarter of 2009 on the order of about 5% annualized. We may also see declines in real GDP on a sequential basis of around 2% in the second quarter and 1% in the third quarter of 2009. We believe the fourth quarter of 2009 will be the first to register positive economic growth. As we look in 2010 we expect a steady acceleration in the GDP growth rate as the year unfolds and some modest acceleration thereafter.

Fiscal stimulus will continue throughout 2009, 2010 and into 2011, most notably in the form of President Obama’s infrastructure program. At least for a while, all is going to look right with the world. Corporate earnings will improve starting in late 2009 and continue in 2010. It is likely that when the economic recovery finally arrives, it will be U-shaped. Inflation should remain under control in 2009, 2010 and 2011, simply because we have so much idle capacity, not only here in the United States but around the globe.

We are expecting choppy stock market conditions in the first half of this year. During this time, the market may continue a base-building process, which it has been doing for the last four months and which typically precedes a recovery. In the second half of 2009, as anticipation grows of an economic recovery, we would expect a much stronger market in the form of a recovery that will carry through well into 2010 and 2011.

Particulars

• There are two risks to our reasonably optimistic scenario. One is the near-term risk that an economic recovery doesn’t develop on schedule but rather comes instead around the middle of 2010. If that were the case, then financial markets, both debt and equity, will be in trouble. In particular, equity markets cannot discount recovery a year and-a-quarter in advance. If the recession proves deeper and more prolonged than initially anticipated, the equity market would be in for a rough time.
• Longer-term, beyond 2011, we face heightened inflation risks. We are pouring unprecedented levels of liquidity in the form of fiscal and monetary stimulus into the system. At some point, the government must start mopping up excess liquidity or risk another bubble.
• Another risk could emerge if Americans decide to significantly increase savings. If the savings rate advances to 7% to 9% of income instead of 1-1/2% of 2009, it creates a macroeconomic problem. The change might be good for individuals but would spell disaster for the economy. We hope to see a very gradual increase in the nation’s savings rate.

Opportunities and Threats

• We believe the next few months is a good time for investors with long-term time horizons to be in equities. We expect periodic rallies in the next few months, followed by periodic declines. Given our long-term point of view, that equity markets are going to recover later this year, investors may do well to be moving into the equity market and certainly not out of it.
• We are positioning the portfolios to take on a little more risk over time in a disciplined, orderly way. We’re focusing on our strength – identifying attractive companies with strong fundamentals.
• We believe in the early part of the market recovery, we will see growth outperform value, although both style groups may gain ground. In the near term, we favor growth. Longer term, we see value outperforming. As the market advance lengthens, probably sometime at the end of 2009 or early 2010, we expect value to begin to perform well. This reflects the fact that deep cyclical stocks, in general, should experience robust earnings growth in 2010 as the economic expansion takes hold.
• In the near term, we favor large-cap stocks based on their liquidity, strength and staying power. Eventually, small caps will do well but this may come a little later in the cycle. While we’ve already had some rallies in some low-quality companies, moving forward, we expect that to dissipate. Future rallies will be led by high-quality and mid-quality companies.
• Among financials, some major, additional write-downs of assets are likely in the near term. This will involve a wide array of companies, not just banks. Given this concern, financials stocks might lag the general market.
• We expect continued severe earnings weakness in some of the deep cyclicals, such as capital spending stocks and materials stocks. In some cases, that’s fully discounted in the price of the stocks. In other cases it is not.
• We see opportunities in technology. As market recovery commences, investors may turn to high-beta stocks, which are prevalent in the tech area. Technology will be an attractive place to be in the next six months to two years.
• The collapse in commodity prices in 2008 has created attractive opportunities, especially among energy companies. As the economy recovers, energy demand will increase. We’re going to go back to some equilibrium point in oil prices. There are plenty of attractive companies in the oil service sector, including Weatherford and Schlumberger.