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 November 2009 Propped-Up Progress
The strongest period of the year is typically November through January with an average 4.4 percent return. Based on that, investors should be gearing up for more gains, yet from November 2008 through January 2009 stocks actually dropped 23.3 percent. This isn't just bizarre seasonal factors, either. Stocks have been rising along with crude oil prices although the two have historically moved in opposite directions. The national debt is skyrocketing yet interest rates are hovering around zero. The dollar is hitting new lows against other major currencies despite signs of domestic economic recovery. In effect, historical relations are being overshadowed by the fallout from the recession. More precisely, it's distortions of government intervention in the economy.
Government Assistance
At some point, however, the Fed will have to step back and let the credit market run its natural course. What that happens -- and more and more economists are calling for it to be sooner rather than later -- the yields will quickly rise. This is especially true for long-term yields because the government will be flooding the market with new debt throughout the foreseeable future. Rising interest rates typically go hand in hand with rising inflation. Then again, that's under normal conditions when fixed income investors' fear of inflation is able to take its natural course. Inflation erodes the value of bonds, particularly those with longer maturities, so under such conditions, investors require higher yields to offset inflation risk. But with annual inflation currently holding at 0.8 percent, most investors aren't too worried. The Fed certainly isn't, that's why they've been comfortable holding short-term rates near zero. This time around, it's much more likely interest rates will jump because of supply and demand issues. All that new government borrowing to fund this year's spending spree is flooding the credit market with supply. In the last week of October, the Treasury issued another $123 billion (that's billion with a 'b') in bonds and issuance will have to escalate over the coming years. With so many new bonds arriving over a short period of time, higher yields will be necessary to spark buying interest. Three or four percent on a ten-year Treasury just won't do it. The dollar is also encountering its own supply problems. Low interest rates may be keeping the economic recovery going, but at the same time they're taking their toll on the U.S. dollar. Lots of dollars floating around are not only the seeds for inflation; they're also sending the currency to its weakest levels in years. In October, the dollar hit all-time lows against the euro and it wasn't because the European economy is stronger -- it's actually weaker. Instead, it was because there are simply too may dollars in circulation, thanks again to the U.S. government's reflation.
Stocks for the Short-Term
The first reading on third quarter GDP is a good example. On the face of it, it looks great: 3.5 percent growth when experts expected 3.2 percent. This was the first real growth since the second quarter of 2008, a definite improvement. But looking deeper it's really just a government shell game. Consumer spending jumped 3.4 percent after falling 0.9 percent in the second quarter. That sounds great, but in reality the increase was artificial, fueled by the government's giveaways in the "cash for clunkers" and tax credits for first-time homebuyers. These two free-money programs alone increased reported GDP by 2.4 percent while other increased government spending accounted for another 0.6%. Remove these one-time infusions and real, sustainable growth was actually 0.5 percent.
Possible Turning Points Unemployment -- The current administration would like to downplay its importance, but unemployment is a major factor determining the course of the economy. Even the White House has to concede it will peak somewhere over ten percent before it shows any real improvement. The ill-fated stimulus bill was supposed to head off unemployment, but actually had little, if any, effect. To make matters worse, unemployment has historically risen up to a year after the end of a recession. This is precisely what happened after the previous two recessions -- even as stocks recovered. With over seventy percent of the U.S. GDP coming from consumer spending, it's hard to see how either can sustainably grow as long as the unemployment rate is high and consumers remain concerned. Whenever GDP truly does resume an upward path, the consumer will drive it, yet that won't happen until consumers are back at work. The Dow Jones Transportation Index -- The Dow Theory is based on the relation between the Dow Jones Industrials and the Dow Transports. Although it's a technical indicator, it's actually based on a fundamental truism: Goods that are manufactured have to be delivered to the point of sale and end users. If businesses are producing products, the transports have to carry them. Earnings can be embellished by cost-cutting or one-time gains, but again, those aren't sustainable. True growth can only come from increased top-line sales, and that involves transferring goods from plant to market.
When both manufacturing and shipping are working in tandem, all business (and therefore stocks) benefit. The Dow Theory postulates that strong transports and industrials signal a strong market. If the two hit new near-term highs together, that's a confirmation of the bull market, the opposite confirms a bear. Ever since the March market lows, both averages have moved higher, yet by the end of October, the transports were showing signs of weakening. Arguably, this could indicate the summer's sales were the result of inventory liquidation rather than new goods coming to market. Again, the "cash for clunkers" program would be an example. Simply liquidating inventory will not lead to immediate growth, only the production of new goods can do that. In the current environment, it's more informative to compare reported earnings to the health of the transports. If manufacturers continue to post improving profits while transports begin to lag, the real recovery is still somewhere out in the future. The Dollar -- Despite paying lip service to a strong dollar, the current administration has done nothing to shore it up. In the short-term a weak dollar can help domestic exporters by making their products cheaper abroad. But in the long-run, a weak dollar discourages foreign investment and entices U.S. investors to look abroad for greater returns. That's a condition we have now with foreign stocks offering better investment potential than their domestic counterparts. This year's equity run-up has made this difference even more glaring, leaving U.S. shares more overvalued relative to foreign stocks. This pattern will eventually reverse when the dollar finally begins to appreciate versus other currencies. This will be the most positive signal for investors. The government will have a difficult time extricating itself from the markets. Until that happens, the markets will not be able to operate under anything even mildly resembling normal conditions. In the meantime there will be a number of seemingly contradictory forces and occurrences. It's not worth wasting time trying to gauge them. One thing is a virtual certainty: Increased government spending and ultimately increased taxes will eventually have a long-lasting effect on the U.S. economy. While the magnitude of their impact is largely unpredictable, those of unemployment, transportation stocks, and the dollar are much more reliable in the short-term. Government subsidies will eventually go away, but these factors won't. Search this site! Just enter you key word or words:
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OR THOSE WHO LOOK TO THE PAST for insight into the future, the past twelve months have been aberrant. Consider, for example, the "scary" months of September and October. Going back to 1926, the S&P 500 has experienced an average loss of 0.5 percent over this period. In 2009, however, there was a gain of 1.5 percent -- and that's even after the late-October sell-off. The four months from May through August historically return 4.3 percent, but this year stocks jumped 17.9 percent.
