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Market Update – There’s nothing like being in love

Posted At : August 18, 2009 2:37 PM

The market continues to take a dreamy view of the “recovery”, firmly believing that it is fully underway. The economic #’s have been pretty good as we have been expecting from massive government spending. People clearly expect this recovery to be like all the others with a surge in business activity with the unemployment level lagging behind. A surge in productivity is typical at this stage in the business cycle as the economy transitions from the bottom of a recession to the start of an economic recovery.  Businesses generally see a modest pick-up in demand for their products, but are reluctant to add workers or boost production/services until this increased demand shows itself to be consistent and is expected to continue.  Subsequently, as the economy strengthens, workers are added, production is ramped up and output rises.  Another important component of rising productivity is it helps keep inflationary pressures down.  In effect, businesses are able to absorb rising costs via increased output per worker.

So, stocks are rising because they believe they are anticipating better economic conditions ahead. Interestingly, the same news that made investors bearish a year ago is making the market rally. The third quarter is likely to be positive, especially given the success of the “Cash for Clunkers” program which Congress extended with another round of spending which taxpayers (our kids) will get to pay off, or more likely pay $50 million per year for decades in interest. Essentially, we are moving up car sales today which would have been made later, except that if you can get someone else to make your down payment, why not make that purchase today? A very great deal for the consumer. Given all the government spending, it will be hard for GDP to not show a modest gain.

For the short term, the market is acting like it is in love with those dreamy eyes, either ignoring reality or simply believing (sometimes believing in something is just believing) that this recovery will be like all the others. It will not! However, I am not ready to call an end to the current rally. I went positive on March 11th largely because sentiment was so incredibly negative and I want to see more positive sentiment before selling. Although the market has rallied almost 50% from the bottom, there is still too much pessimism for the rally to be over. However, we are getting close. The AAII sentiment figures went to 50% (Last Sunday’s Barron’s), the first time at this level since the rally began.

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