The markets are somewhat confusing right now.
For the 9 weeks beginning Monday July 17, the Dow has rallied from around 10,750 to today’s close of 11,560 – a 7.5% rally. Over the same period the S&P 500 has rallied from around 1235 to today’s close around 1320 – a 6.9% rally. The Nasdaq has risen about 200 points from 2035 to today’s close around 2235 – a 9.8% rally. The yield on the 10 year treasury bond has gone from over 5.2% at the beginning of July to today’s close around 4.8% after having risen for the first half of the year.
What is this all about?
Mainly, I think, the Fed pause on August 8. Why then did the market start to rally three weeks prior to the Fed pause? Because they saw it coming. I think that people started to see that housing was slowing, that the economy was cooling as a result and they began to anticipate a Fed pause. A Fed pause, of course, reduces interest rate pressure on households and corporations. When the Fed actually did pause on Tuesday August 8, the rally was on for real.
Home builders have been rallying pretty well since July 17 and now with the Best Buy quarter I think the “soft landing” crowd is out in force. People with this view don’t believe the economy will fall into a housing/consumer led recession and therefore that corporate profits and stock prices will hold up. If you have that view, stocks represent a pretty good value right now.
Tom Petruno, Market Beat columnist for the LA Times, echoed my sentiments in an excellent piece in today’s LA Times:
After a nerve wracking mid-May to mid-June slump, the stock market spent most of the summer slowly working its way higher – slowly enough that the rebound may have gone largely unnoticed by many investors.
Key to the bullish outlook is faith that the US economy is experiencing a soft landing after three years of strong growth. What’s implied by code words such as soft landing and ‘mid cycle slowdown’ is that the deceleration eventually will give way to faster growth, rather than to a recession and a collapse of corporate earnings.
Fed policymakers boosted hopes for a soft landing when they opted at their August 8 meeting to hold their benchmark short term interest rate at 5.25%, after 17 consecutive hikes.
If the stock market were seriously confronting the possibility of a recession – and falling corporate earnings – it’s highly unlikely share prices would be where they are now.
He points out that economically sensitive stocks (industrials, commodity-related, small caps) have been getting sold while consumer and business staples have been getting bought:
…….. shifts in the broad market over the summer show that many investors have been repositioning their portfolios for weaker economic growth.
Shares of many industrial and commodity related companies either have been slow to rebound from the spring sell off or have continued to fall.
Likewise, small company stocks, on average, remain well below their all time highs reached in spring.
Nervous investors’ preference in recent months has been for big name companies (less chance of financial calamity in a recession, people figure) and for those firms whose sales are less dependent on the economy’s strength. Cases in point: Shares of drug giant Pfizer Inc. and McDonald’s Corp. both hit 52 week highs last week.
Where to from here?
[I]f the economic soft landing is for real, there should be more to come for laggard domestic stocks, said Larry Adam, investment strategist at Deutsche Bank Alex Brown in Baltimore.
US equities, he said, could gain, particularly if investors continue to see less potential in commodities and residential real estate, which have attracted mountains of money since 2002.
As capital looks for somewhere better to go, ‘I think you have a pretty solid outlook for stocks,’ Adams said.
As I’ve said before, I’m not so sure about that. We’ll have to wait and see how earnings come in for economically sensitive stocks in the 3rd and 4th quarters to see if the soft landing or the hard landing crowd is right.
Personally, I’d position myself for a hard landing. I’d stay away from economically sensitive stocks (home builders, home improvement retailers, banks – anything real estate related; consumer discretionary stocks like apparel retailers and casual dining chains; etc….). I’d cut back my commodity related positions, which depend on global economic growth, though I wouldn’t sell them entirely. I’d have positions in quality consumer staple stocks like utilities, food companies, personal and household goods companies, phone, cable TV and garbage companies. I’d have positions in defense stocks whose earnings should hold up in an increasingly dangerous world. And I’d increase my cash position in the form of gold and gold equities (more on this at a future time).