Positive Outlook vs. Media Double Dip 8/23/10

It may come as a surprise to you that I am turning positive on the stock market, especially in the wake of all of the media deflation and double dip talk. The last time I made a market projection like this was in June/07 when I suggested that the economy has a recession every 3-5 years—a time when the media said the market had significant upside. Recent earnings reports and company outlooks are projecting increasing earnings going forward and at an 11 times forward price earnings ratio on the S&P 500 the market is not overvalued.     (Source: First Trust)

 

My July memo said that if the leading indicators continue up, I would add to equity positions and if not, raise more cash. At the moment I am doing nothing, because the market is in a trading range, still technically broke, and September tends to be a down month for the stock market; unless things change significantly, I will be reducing cash in favor of equities in September/October. I believe the risk in taxable bonds, particularly Treasuries, is high at the present time.

 

Predicated on my phone conversations with some of you it is clear that investors are worried the economy is falling back into recession. The negative sentiment reflects the media focusing on the negative rather than the positive. Clearly there are many problems: high unemployment, weak housing, high debt levels, much uncertainty &higher taxes for next year, etc. Too, last week the Federal Reserve released its statement after the FOMC meeting acknowledging economic weakness, but being optimistic for 2011. What the Fed is doing (such as buying Treasuries and printing money) to prevent deflation helps to explain the simultaneous bull markets for Treasuries and gold.

 

 

In my opinion, things are not as bad as portrayed by the media. The economic expansion has slowed during the past few months, but the economic output is increasing, not decreasing as in a recession. This is not like March of 2009 when the risk of financial institution collapses was high.   Consider the following:

 

·         Monetary policy remains accommodative, interest rates are at historical lows, and M2 (the total amount of money available to the economy) is expanding—not declining.

·         Credit markets are getting much better and functioning more normally.

·         Corporate profits are rising.

·         Consumers are spending cautiously.

·         Private sector companies are slowly hiring workers again, but not at pace quick enough to meaningfully bring down unemployment rates.

·         Businesses are ordering goods to replenish inventories.

·         Global trade is growing again, increasing demand for US goods.

·         Businesses are resuming capital equipment and technology purchases postponed in the recession.

·         Inflation is contained for now, allowing consumers and businesses to stretch their spending further.

 

The morning talk shows are great entertainment, but poor true reporting. The hedge fund gurus who are long Treasuries (with a large profit) play into deflation fears, but as the retail public pulls out of equity mutual funds and into bonds out of fear, they are selling. In June, when the market was bottoming out after gains earlier in the year until late April, the institutional players as noted by watching block trades (10,000 shares or more) of stocks were up as the retail public was selling out. (Source: First Trust) The media suggests the US has lost all of its manufacturing jobs and we produce little as a country anymore. That is hogwash. True companies naturally go where the economics work best in a competitive global economy, but we still produce 19% of the worlds manufacturing output by ourselves.   The BRIC countries, Brazil, Russia, India, & China combined produce 21%.(Source: First Trust)   Unfortunately you don’t hear anything like these facts on the news.

 

In summary, investors are worried about a double dip recession even though many of the conditions which historically lead to recovery currently exist. There is likely more seasonally downside risk in stocks short term. However, if the fundamentals remain positive and the market declines, it will be a buying opportunity and that is what I intend to do with your money.