If you think we’re beginning to see the light at the end of this recent equity downturn, you’re not alone. Citi analysts write that while a slowdown in leading indicators and the crisis in Europe are currently frightening investors, this sort of slowdown in the middle of an economic cycle is normal, and we should come out of it.
Further, EPS growth is going to continue, and that’s good news for stocks.
Investors may be underestimating two factors that should ensure solid EPS growth for the next few years. First, the corporate revenue leverage to a growing economy has risen. This means companies can now generate faster revenue growth per unit of GDP growth than they did a decade ago. Second, companies are still successfully containing costs. This has been an outstanding feature of the current earnings cycle and has meant profit margins are now approaching previous highs. There is little to suggest margins will retrace anytime soon.
Our view is that global stock markets should Grind Higher with EPS, which is typical for the third year of recovery. Our MSCI ACWI 2011 year-end target is 380 (currently 333). The strategy during the Grind Higher phase is not to chase rallies too hard but be prepared to buy into dips. We think the recent pullback provides a buying opportunity (Figure 3).
So while we’ve drifted a bit lower, now is the time to buy into “The Grind Higher,” according to Citi.
Of course, if something else goes wrong with Greece or the debt ceiling situation blows up, there might be an even lower buy in point to come.
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