Equity Market May Extend Gain as Factory Output Rises, ASR Says

By Alexis Xydias

Oct. 9 (Bloomberg) -- Rising industrial production and a rebound in U.S. employment will push stocks higher around the world, according to Absolute Strategy Research Ltd., the London- based firm that told clients to buy shares in March.

Companies will need to re-stock inventories that were depleted more than necessary as consumer spending increases, boosting prices and helping employment recover in the world’s largest economy, said ASR, founded in 2006 by former Merrill Lynch & Co. and UBS AG strategists. Alcoa Inc. said this week in its earnings report that the replenishment of falling customer stockpiles will boost aluminum production.

“The corporate sector was forced into a much more aggressive response” than needed because of speculation that the global recession would extend into next year, David Bowers, strategist at ASR, said in an interview on Oct. 6. “The recovery in 2010 is about corporates repairing their cash flows and building up inventories.”

The Standard & Poor’s 500 Index’s seven-month rally paused last week as data showed U.S. manufacturing expanded less than predicted in September and unemployment climbed to a 26-year high. New York University Professor Nouriel Roubini said stocks “have gone up too much, too soon,” in an Oct. 3 interview from Istanbul, while the recovery is losing momentum, according to Nobel Prize-winning economist Joseph Stiglitz.

‘Challenge Investors’

U.S. unemployment will keep rising, while gains in the stock market show investors are “irrationally exuberant” about a recovery, Stiglitz said on Oct. 5 in a Bloomberg Television interview from Istanbul. Billionaire investor George Soros said the same day that any economic improvement will be “very slow” as “basically bankrupt” financial companies impede it.

“The assumption being made across the board is that unemployment won’t come down,” said Ian Harnett, ASR’s director of European strategy. “That will challenge investors in the next six months. If that is wrong, it will take the bond market to pieces. What we’ve got is this real possibility for equities to rise another 20 percent.”

In a note distributed on March 6, ASR advised buying European shares because investors were ignoring the likelihood that economic growth would resume. Gross domestic product in countries using the euro is estimated to have contracted 4 percent in the third quarter and will shrink 1.9 percent in the last three months of the year before expanding 0.95 percent in 2010, according to the median estimates of economists surveyed by Bloomberg.

Global Recession

Europe’s Dow Jones Euro Stoxx 50 Index has rallied 60 percent since falling to a 12-year low on March 9. Equities gained as earnings exceeded estimates and $12 trillion committed by the Group of 20 nations spurred optimism the global economy would emerge from its first recession since World War II.

Three companies in the S&P 500 announced second-quarter profits that beat analysts’ estimates for each that missed, data compiled by Bloomberg show.

The Washington-based International Monetary Fund raised its forecast for 2010 global growth last week, saying the economy will expand 3.1 percent, more than a July forecast of 2.5 percent. Recessions in Germany and France, Europe’s two largest economies, unexpectedly ended in the second quarter.

Companies are restarting production amid a pick-up in sales, ASR said. U.S. car inventories fell to the lowest level in at least 24 years at the end of August because of demand during the “cash-for-clunkers” program, according to data from researcher Ward’s AutoInfoBank of Southfield, Michigan.

Alcoa, Toyota

Manufacturers’ stockpiles shrunk at a slower rate in September as the Inventories Index of the Institute for Supply Management’s report reached 42.5 percent. The index is 8.1 percentage points higher than the 34.4 percent reported in August. A reading of 42.6 is the dividing line between liquidation and replenishing of goods.

A Commerce Department report yesterday showed inventories at U.S. wholesalers dropped in August for a 12th consecutive month, clearing the way for a pickup in orders as sales improve.

Alcoa, the biggest U.S. aluminum producer and the first Dow Jones Industrial Average company to announce results for the third quarter, said Oct. 7 that global consumption of the metal will climb 11 percent in the second half. Shares of the New York-based company, which cited “low inventories” at distributors for its forecast, gained 1.1 percent yesterday.

Toyota Motor Corp., the world’s largest automaker, is boosting production after demand surged in August, Don Esmond, Toyota’s senior vice president of U.S. sales, said this month. The Toyota City, Japan-based carmaker began the month with an 18-day supply of vehicles, the executive said. The industry standard is 60 days.

‘More Upside’

“There is definitely more upside than downside -- perhaps as much as up 50 percent,” the ASR report in March said. Bowers was previously chief global investment strategist for New York- based Merrill Lynch, where he worked for 11 years. Harnett was previously a European strategist at Zurich-based UBS.

The S&P 500 slipped as much as 4.3 percent from an almost one-year high of 1,071.66 on Sept. 22, dragged down by a decline in the Tempe, Arizona-based ISM’s factory gauge to 52.6 last month from 52.9 in August. The measure topped 50, the dividing line between expansion and contraction, in August for the first time since January 2008.

Demand for U.S. durable goods unexpectedly fell in August and sales of new homes rose less than forecast, reports showed last month.

‘Headwinds’

“The headwinds for economic growth still remain strong,” said Neil Dwane, who helps oversee $80 billion as chief investment officer at Allianz Global Investors’ RCM unit in Frankfurt. “Any recovery we get will be disappointing relative to current market expectations.”

Central banks trying to revive growth will probably hold borrowing costs at or near record lows, Harnett said. That will spur inflation, boosting assets such as equities, he said.

The European Central Bank left its benchmark lending rate at a record low of 1 percent yesterday. The U.S.’s Federal Reserve has frozen the rate banks charge each other for overnight loans between zero and 0.25 percent since December 2008.

“We could end up in a world where growth is much higher than people expect,” Bowers added. “People are desperate for the jobless recovery. If this rally continues, it is career- threatening for a lot of investors.”

To contact the reporters on this story: Alexis Xydias in London at axydias@bloomberg.net.