Economists to Investors: Buckle Up

The volatility of the recovery was on full display last week as global markets plunged. Europe’s troubling debts triggered new anxiety that threatened to put the upturn back on hold.

Still, most economists and market strategists called for a little perspective. They told investors and clients that this particular recovery was never branded as a smooth trip back to the top but that recent market enthusiasm may have inadvertently lifted the bar.

“What a difference a year makes,” the T. Rowe Price Winter 2010 Report began. At this time last year the global economy was reeling from the worst meltdown since the Great Depression, and investors were enduring the worst bear market since then,” the Friday report said. “By contrast, 2010 opened with investors heartened by the sharpest recovery they’ve ever seen but warily wondering whether huge gains off market bottoms can be sustained.”

Maybe they can’t be sustained to the penny, said David Bianco, chief U.S. equity strategist at Bank of America/Merrill Lynch. Even ahead of last week’s big index plunges, he wrote on Feb. 1 that this is a tough market to please, but that could be good for investors.

“For the second quarter in a row, the S&P 500 has experienced an over 5% pull back right in the middle of a strong earnings reporting season,” he wrote. “While the situation in Greece, risk of more regulation in the U.S., and policy tightening in China and other emerging economies are a reminder that risks to U.S. and global growth still exists, but there are many signs that growth is also improving. As we advised during the October dip, we encourage buying through the current weakness.”

One reason for such optimism is that more companies reporting quarterly earnings were beating revenue estimates rather than earnings estimates, wrote Nicholas Bohnsack of Strategas Research Partners. Because earnings can be – and certainly have been – goosed by clever financial engineering, revenue is an important gauge of recovery. He said a proprietary group of bellwether stocks with the highest correlation to nominal GDP growth are looking good and that the outlook for the global economy and corporate visibility is significantly improved. Revenue expansion is likely to follow through in 2010.

“Lost in the drama of the market decline over the last two weeks has been the strength of the corporate earnings season – particularly on the revenue side,” Strategas founder Jason Trennert wrote on Feb. 1. At that point, about 45% of the S&P 500 index had reported earnings, and close to 70% of S&P 500 companies had beaten the top-line estimate while 78% had beaten earnings estimates. “The path to a sustainable recovery is likely through revenue expansion from here (cost-cutting appears to be running its course) – we believe this is a good bet at this stage of the cycle.”

Citigroup (C) small- and mid-cap equity strategist Lori Calsavina called the recent tumbles a garden-variety pullback, and said on Tuesday that the only wrinkle was the timing. “We’ve been surprised by how early in the year the recent correction and sector leadership rotation have occurred,” she wrote. “We had expected the first major pullback in 2Q when Fed rate hike fears set in, but concerns about tightening in China seem to have pulled those trades forward, at least in part.”

Stuart Hoffman, chief economist at PNC Financial, wrote on Feb. 1 that wages and salaries, and thus personal consumption, are “still hobbled by a weak labor market” – a point supported by the Dow’s dip below 10,000 after Friday’s job numbers would tend to support.

But it wasn’t just the employment situation that had traders down last week. Greece’s debt woes, uncertainty over health care legislation, China’s credit tightening, and President Obama’s bid to push for financial sector reforms all clouded an otherwise clear picture.

Arnaud de Servigny, head of research analytics at Barclays Wealth Americas, offered a more eloquent variation on the advice most nervous investors need and often fail to heed: Be cool, it’ll balance out.

“We do not see any reason to overreact to recent events,” de Servigny wrote on Wednesday. “Economic recovery will of necessity be gradual, and policymakers will need to take a range of actions along the way as they strive to regain credibility and restore much-needed stability to the economic environment. We know that there will be other problems down the road. We also know that consumers’ economic health must remain of concern, especially in the context of high unemployment. The good news is that, for the time being, corporates appear able to take the lead and show the way ahead.”