Does The Economy Matter

The macroeconomic situation continues to worsen. Spanish spreads are at a record while Italian rates are above 6%. We have seen a big rally in technology as results have been less worse than feared. How long can the rally in stocks continue as the global economy deteriorates?

I believe the risk/reward from current levels are poor. It is pretty clear that there is downward pressure on earnings. Valuations are reasonable so we could see some P/E expansion as long as profits don't fall out of bed, but given the deteriorating profits outlook upside is likely to be limited. However, there is also the risk that the deterioration in profits accelerates and the downturn in the economy worsens. I believe the upside is limited to a few percent while the downside potential is quite large.

 

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