US equities will end the year stronger, predicts BlackRock strategist

Though the U.S. economy will grow at a below-trend pace in 2007— and the equity markets will remain volatile— stock prices should still end the year higher than they are today
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Though the U.S. economy will grow at a below-trend pace in 2007— and the equity markets will remain volatile— stock prices should still end the year higher than they are today, according to Robert C. Doll, vice chairman and global chief investment officer of equities, BlackRock.

"We are maintaining a reasonably constructive outlook for the equity markets for 2007, with 'constructive' signalling an up year," Doll said in his annual mid-year update and outlook for the economy and financial markets. "The underlying message to investors is to be realistic. Recognise that we're in a lower return/higher volatility environment, where the tailwinds of the bull market are not as strong as before. It's an environment where skilful security selection will remain paramount."

According to Doll, second-quarter U.S. GDP growth is expected to come in above the 3 percent mark, which would erase some of the weakness from the first quarter. "For the second half of the year, we expect GDP growth to be somewhere in the 2 to 2.5 percent range, figures that remain below the long-term trend, but that are still strong enough to keep earnings advancing," he said.

Short-term concerns for the markets include higher bond yields as well as the possibility of a near-term equity market correction precipitated by technical factors. "In recent years, periods of economic weakness have tended to trigger falling bond yields, which in turn helped to provide a relief valve for stocks," he said. "That clearly is not happening now. Nevertheless, our long-term view for stocks remains positive. Valuation levels are still attractive and the fundamental economic and corporate earnings backdrop, although weaker than last year, remains solid and conducive to constructive performance for equities. We continue to recommend that investors maintain overweight positions in equities and to avoid overreacting to potential short-term setbacks. This strategy has worked well in recent years and it should continue to do so."

Ongoing speculation about the Federal Reserve's next interest rate move continues to lend uncertainty to views of the market's prospects. Doll, who has been publishing his annual "10 Predictions" for the year ahead in the financial markets and the economy since 2001, notes that climbing long-term bond yields, along with ongoing concerns about inflation, have resulted in a consensus view that there is now close to a zero percent chance that the Fed will lower interest rates this year.

Doll anticipates that U.S. inflation will remain low, but periodic worries about inflation will surface due to strong world growth, the commodity boom and a weaker dollar.

"For our part, while we continue to believe that the Fed's next move will be to lower interest rates, it does appear less and less likely that that move will come anytime soon," he said. "We nevertheless are still holding out hope that weaker growth and low inflation may prompt the central bank to act before the year is out."

The U.S. export surge illustrates that the world has now moved from a period when the U.S. consumer was the main source of demand growth to a more broadly driven global economy. "Though the U.S. economy will grow at a below-trend pace throughout most of this year, strong growth internationally will provide some offset to weaker demand in the U.S.," Doll commented. Global real economic growth should be in the 4 to 4.5 percent range in 2007, compared with 2 to 2.5 percent in the U.S. "The trend speaks strongly to the case for global investing. More and more — and particularly in the U.S. — investors need to be diligent about looking beyond their own borders for the market's most attractive growth opportunities," he said.