Despite the recession in the residential housing market and the liquidity crunch in the credit markets triggered by subprime mortgage concerns, the stock market has performed well thus far this year. It’s true the economy is slowing….but that has been predicted since the end of last year. Consensus forecasts are that GDP will continue to grow in the 1 to 2 % range for at the least the next two quarters.

Since fully 30% of the S & P 500 earnings are generated overseas, corporate earnings are less affected by turbulence in our domestic economy. In addition, the weaker dollar translates into higher earnings for companies with substantial international exposure. On the other hand, earnings will come under pressure from the slowing U.S. economy.

Probably the best news about the U.S. equity market continues to be its relatively low historic valuation. The S & P 500’s trailing P/E of 16 to 17x is its lowest in ten years and a forward looking P/E of 14 translates into a 7.14% yield. That makes stocks look good compared to a 4.5% yield on 10 year treasuries.

Of course, the forward looking P/E is totally dependent on the E (earnings). In order to mitigate the risks to corporate earnings associated with the slowing U.S. economy, we still favor large cap growth stocks as they tend to outperform in an environment of S & P earnings deceleration and a weaker dollar. In addition, as we have been saying all year, investors should consider increasing their allocation to foreign markets. While there are certainly risks with international investing, we see that the global economy appears to be transitioning from being U.S. led to emerging markets led. Foreign and emerging markets obviously have less exposure to the U.S. housing market and should benefit from above average global growth.

© 2007 Childs Company