As we have said repeatedly over the years, markets can take on lives of their own. In the short term confirming fundamentals are not required. Market prices, however, can’t diverge from fundamentals indefinitely.
Other than the solidly entrenched problems with unemployment, most economic measures are improving, and a great many economists opine that the recession might be over. Except for people directly affected by unemployment, as a country we are breathing a collective sigh of relief. We feel that conditions may have bottomed and started to rise. Investment analysts have seized on that change of direction and are celebrating the dramatic percentage improvement in a great many economic measures. The equity markets have rejoiced in the turnaround as the 60% gain from March 9’s bottom is close to the largest six-month advance in U.S. history. In past recession recoveries, stocks have never achieved such a percentage gain until the economy had been out of recession for many quarters and all question of possible relapse had been put aside.
In this current attempt at recovery, despite improving economic statistics, there is no proof yet that the recession has ended. With unemployment still worsening and tremendous fragility remaining in financial institutions, the potential certainly remains for the economy to dip again.
It is important to evaluate properly the strong percentage improvements we’ve seen in select economic statistics. Most of the bounces are off severely depressed levels, so the percentage improvements may be misleading. A look at multi-year graphs of various economic data show a common pattern. For example, an index may have declined from 10 to 2 from peak to trough. A bounce from 2 to 3 since the trough is a very impressive 50% improvement, but it leaves the index still severely depressed from its earlier strong levels.
Recent headlines celebrated a $2 trillion improvement in household net worth. Much of that came from the stock market surge, and is good news. On the other hand, household net worth had declined by $14 trillion in the prior decline, so we are not even close to having repaired our collective balance sheet.
There is great speculation that Asia will lead the world out of its current slowdown. Asian economies have grown in recent years largely with an export orientation. The U.S. consumer has been the buyer of last resort. We are strong believers that the U.S. consumer’s behavior has been altered for years to come. A recovery based on the expectation of a rapid resumption of historically normal consumer behavior is likely to be surprisingly weak. Once the bounce initiated by government stimulus and inventory rebuilding has to rely on the consumer, its forward progress may slow considerably.
While they may have little effect in the short run, these issues should call into question longer-term stock market potential. Assuming high levels of risk over the past few months has been the surest path to profits. The lowest quality junk bonds, for example, have outperformed almost all other asset classes. That performance won’t continue indefinitely, but no one can forecast the top with certainty. The broad rally’s ability to continue higher depends mostly on investor confidence, which feeds on itself as the market pushes higher.
Although markets are significantly overbought in the short term, most technical measures point to even higher prices. At current valuation levels, however, we dwell in the realm of the trader, not the investor looking for sound fundamentals in his/her portfolio holdings.
Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.