Posted At : May 4, 2009 10:13 AM
Stock Market Update: Gotta love those rose colored glasses!
The market continues to see the glass as half full and awfully rosy. Exactly the opposite of a few months ago. It seems that investors are bidding up stocks simply based on the relief that they will survive, regardless of what a company earns. A truly interesting way to invest. However, just like the recent slide was a test that the market will go down forever and ever because the news was bad, earnings are the reason to buy a stock and earnings will be modest at best. Yet, you should never underestimate emotion. Emotion is irrational, and can cause extremes in both directions.
I am pleased that my work was so early to recognize the start of the rally, (March 11th commentary). I credit the success of my forecasts to being able to identify emotional trends as much as quantitative and technical studies. And I can say that in my 25 years in business, this is as emotional a time as any I have ever seen. There is no substitute for experience. (if I don’t toot my own horn, who will!) Just as the market plunged in an emotionally charged time, stocks can continue to rally on emotion that the bottom is in place and things just have to be getting better. Like the administration’s policies or not, all the money that is being thrown into the economy is going to take hold…at least temporarily. That is what is driving the market higher right now. The big question will be whether it translates into sustainable earnings growth for companies or just provides temporary relief. Over the long term, earnings drive stocks well after the emotion has subsided.
Short term: things look rosier than they have in a long time. The market is definitely due for a correction that might even get a little scary, but we are all breathing a collective sigh of relief…if only just for Spring. We must keep in mind that bear market rallies, (make no mistake about it; we are in a bear rally not the start of a major bull market) usually last 2-3 months, and we are approaching the end of the 2nd month. Although, the intense oversold levels the market reached coupled with the relief from systemic risk (a complete breakdown of society) and the optimism of literally trillions pouring in, could make this run last a little longer and quite a bit higher. My guess would be that the rally might fizzle when 2nd quarter earnings come out, and realization hits that survival alone does not equal profits. Remember, stocks go up about 8 months before the news of recovery, so investors are guessing or speculating or hoping that the recovery is in the 4th quarter. It’s all about perception. We just had a great market rally from better than expected earnings, but a closer look will notice that expectations were so low, they weren’t hard to beat. That’s like saying the Kings are so bad they will lose every game and then being ecstatic when they win 10!
Longer Term: As I have been saying (what feels like) forever, consumer spending is slowing, and it’s going to slow for years as savings increase. There are two issues against us here: Demographics – the country is getting older, spending less and saving more (discussed in depth my Economic Tsunami special report) and deleveraging. At one time we were savings 7-8-10% of our incomes, back in the early ’80s. We grew from 63% of the economy being consumer spending, to 71% in 2006. We are going back to the mid –to low 60s in terms of the percentage of consumer spending in GDP. We are not doing it all at once, it’s going to take years; but it will crush our economy.
Economists have a term for this process. It’s called rationalization. We have too many stores to sell “stuff,” all sorts of stuff. Simply, too many malls. We have too many factories to build too many cars, too many plants to build too many widgets for an economy where currently 70% of GDP is consumer spending. When we built all that capacity it was for an economy in which consumer spending was 71%; and because we were enthusiastic and believed we would grow at 3% forever, we probably built it for 73% or 74%. We are watching capacity utilization fall off the table. It is down to 67%, fully 15% below normal. What happens when you see that? You start closing factories. It’s just what you have to do. We are going to have fewer restaurants, fewer clothing stores. The survivors will get bigger market shares; that’s just what happens. Creative destruction my friends.
Investment Strategy: I am not an eternal pessimist, as my clients will attest, nor a Perma-Bear or non-believer in the American Way. On the contrary: I have been bullish for most of 3 decades in this business. Yet the facts are the facts. There is money to be made if you are prepared for what’s ahead. Hope is not an investment strategy. Once this exuberance subsides, stocks will go from their current high valuations to low valuations that are normal for a bear market, and we are halfway through the trip in a secular bear market. Bear markets last many years. If it ended tomorrow, it would be the shortest in last 100 years plus.
Regards – Keith Springer