Fed taking a more accommodative stance
Citi's updated forecast continues to show relatively subdued but sustained economic growth approaching 2%. Unsettled financial conditions remain a drag on the ability of the recovery to gain traction though gradual improvement in the labour market and the resilience of activity in the face of negative shocks have introduced upside possibilities.
Indeed, Citi analysts have slightly raised their forecast for payroll employment growth to just shy of 2 million jobs in 2012, with unemployment now expected to dip to 8.25% by year-end. Recent data also show increasing evidence that activity in the small business sector is picking up, a good sign that the recovery may be gaining self-sustainability.
The Federal Reserve (Fed) recently expanded its communications strategy, enhancing transparency and accountability. Specifically, the Fed extended the likely period of near zero policy rates to late 2014. While Chairman Bernanke was careful not to rule out asset purchases should conditions warrant, there was no indication of a new round of Quantitative Easing (QE).
While equity valuations have slid since the tech bubble of the late 1990s and early 2000s, P/E trends seem surprisingly depressed given the incredibly low interest rate environment. In this context, Citi analysts believe there is ample reason to believe in multiple expansion over the next 12 months.
There is typically an inverse relationship between equity risk premiums and P/E valuation and there have been many reasons to be concerned over the past decade, ranging from wars, sovereign credit woes, a financial crisis to peak margin worries and home price anxiety and high unemployment rates. However, there does seem to be an easing in some of these issues, which suggest higher stock prices.