In the second quarter of 2010, the US stock market reversed the course of the first quarter. The S&P 500 and Russell 1000 were each down -11.4% and the Russell Midcap index retreated -9.9%. This left the large cap indexes in negative territory for the year, although mid cap and small cap indexes are showing smaller losses. The sharp sell-off in May was triggered by the sovereign debt crisis, especially concerns about Greece which then, in turn, led to worries about other Eurozone nations such as Spain and Portugal. The dollar strengthened against the euro as a "flight to safety" occurred.

The US economy is still poised for decent growth in 2010. We estimate that US GDP will expand at a 2.5 - 3% rate. European woes will clip US growth - the stronger dollar will affect companies that export to Europe (though companies exporting to China will benefit from the revaluation of the yuan). Inflation remains low and the Federal Reserve has said that it will keep interest rates low for the foreseeable future. Unfortunately unemployment is still at a high level and job growth continues to be weak. Companies are loath to add to payrolls given the global and domestic uncertainties. One of those uncertainties is the level of worldwide government debt (not only federal, but also state and local). Although corporate profits are still rebounding from depressed levels with a close to 30% increase forecast for 2010, the Leading Economic Indicators are starting to roll over.

Our outlook for 2011 is therefore less sanguine. While GDP growth is likely to be positive, the rate of growth, in our view, will be lower. Corporate profit growth will probably be far lower than this year. The US stock market is likely to show modest gains. This will come from the underlying increases in company revenues which are contributing to earnings growth. However, the level of global uncertainties on political and economic fronts, coupled with burgeoning US debt levels and the prospect of tax increases here, mean that the P/E multiple on stocks is likely to shrink (limiting stock market upside).

In environments like these, we believe it important to continue to focus on companies with solid earnings power and cash flow generation and good quality financial statements. At the same time, valuation is key in avoiding overpaying for stocks with less than satisfactory earnings and cash flows.