Weekly Stocks Recap

Amazing Two Month Turnaround!

Wow, another strong week with the broad market (S&P 500) advancing a whopping 5.9%! That brings the Year to Date performance on the index into positive territory, now at 2.9%. That is an amazing turnaround from the market lows hit on March 9. Over the past two months, the broad market index has risen an incredible 37%, for what is surely one of the best two month performances in stock market history. To many of us, it feels like the worst is over for the stock market, and recent money flows into the market would support that. Late March and April cash inflows were at their highest percentage levels since 2003, which coincided with the start of our last bull market. Net cash inflows are highly correlated with stock market performance, as inflows drive up demand for stocks and prices follow suit. For this recession, we do think that the March lows may turn out to be the stock market bottom. However, we also know that the market cannot sustain 30% plus gains every two months for the remainder of this year. Do not be surprised if there is a bit of a pullback or market consolidation over the next few months. In fact, it might be healthy to see the market take a breather over the near term. However, we suspect there is still a great deal of money on the sidelines that will eventually enter the stock market. Those inflows have the potential to drive the market significantly higher. Our only concern is that the stock market may be getting a little ahead of itself, as the economy is still in decline as we discuss below.

Rate of Decline is Slowing!

Has the recession hit bottom? The evidence suggests that the recession is still very much in force. Most economic measures are still declining, although the rate of that decline has indeed slowed significantly. That slowing rate of decline is what has most investors excited. For example, most manufacturing activity still shows contraction and the unemployment rate continues to rise, although jobless claims did come in lower than expected last week. Measures on GDP continue to show declines, although that rate (pace) of decline is slowing. Housing measures are still very poor and a bottom still appears elusive. However, it is fair to say that the economic news and forecasts today are less bad than they were a few months ago. Those are encouraging signs that we too think are positive. However, we do not think we will see the end of the recession until later this year. In fact, we think unemployment will continue to rise through the end of this year. Real economic growth and job creation may not reverse trend and start upward until 2010. However, the stock market is considered a leading indicator on economic measures, with past history suggesting it will lead the economy out of recession by 6 to 8 months. If March was the bottom that would suggest economic trends will turn positive by the end of the fourth quarter this year. While it will take time for the economy to reverse trend, the stock market has already begun its march upward. The other big news last week was the financial sector. The government released the bank stress tests, and results were better than the market expected. The financial sector exploded, rising more than 23% in one week alone! Also, the 1st quarter earnings season is now winding down. All in all, corporate earnings have come in mostly better than expected, although they are down from prior years. On the other hand, companies have not done as good a job meeting revenue expectations, which we view as a reflection of just how poor the economy really is.

Market Beating Foresight

We are encouraged with the momentum and strength the market has shown over the past two months. However, we are a little concerned that the market and certain sectors may be getting a little ahead of themselves. Yes, the worst is probably over, but the economy is still in decline. Businesses are not likely to start expanding again until next year. The financial sector is a good case in point of after having just risen 23% last week. Now may be a good time to take a little money off the table. If you have large gains in some financial stocks, you may want to sell part of your position. That is what we did when we sold our option position in Bank of America. In our view, financial stocks will likely continue to rise long term from the levels today and still represent an excellent buy. However, a prudent strategy would suggest cashing in on part of those recent gains. Remember, you can always reinvest the gains into another industry or even back into the financial sector after a pullback on longer consolidation period. We subscribe to the old Wall Street adage, “Little Piggies Get Fat, Hogs Get Slaughtered”, which in essence means do not get greedy on any one stock. Despite the big gains, we have no plans to short financial stocks or the market itself as the current momentum is very strong. For those of you that have been sitting on the sidelines, now is an excellent time to increase stock allocations. We would suggest gradually increasing your stock allocation over the coming months rather that jumping in all at one time which will reduce your timing risk over market entry. We too plan to increase our equity allocations now that the bulk of 1st quarter earnings have been released. We remain optimistic on the direction of the stock market, but do have reservations with the pace of recent gains. Volatility could return if the market gets too overextended from what economic conditions warrant. But the real market power lies with the net inflows that drive the market over the next few months. We think there is significant pent up demand that is sitting on the sidelines. As consumer confidence and retail spending gain momentum, that could drive the market sharply higher over the remainder of this year as more investors join the party. All in all, we think the market upside potential is stronger relative to the downside risk. That should make investing at current levels very rewarding over the long haul.