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BSCA Outlook June 2009: Don't Let Your Guard Down Yet
May was yet another strong month for the equity markets. After being down six out of eight months from June 2008 to February 2009, the S&P 500 Index has posted strong returns for three consecutive months. Investor’s appetite for risk has clearly returned as economic data has shown slight signs of improvement. Investors continue to wonder whether this is the dawn of a new bull market or if the current rally is simply a countertrend rally before the market again heads lower. As we stated in our previous commentary, we believe that the arguments for both can be summed up by analyzing economic data and by technical analysis.
For the financial press, the chic phrase of recent months has been “green shoots,” in reference to the bits of economic data that has been better than expectations. Note that the key phrase is “better than expected” and not “good.” Most data still paints the picture of an economy in recovery, but investors are hoping that “better than expected” means that the economy is somewhere near a turning point. Below we highlight a few key data points from the month.
May 2009 Data Points
The first big data point of the month was non-farm payrolls which came in better than anticipated. Economists looked for the report to show a loss of 600,000 jobs in the previous month, but the report came in at only 540,000 jobs lost. This is still not a healthy number for the economy, but it wasn’t as bad as estimated.
The Core Consumer Price Index “Core CPI” was also higher than projected. Normally, economists don’t like to see Core CPI outpace expectations, but the fact that we saw any inflation at all, however small, was seen as a positive. Investors are hopeful that this is a sign that we have avoided the disaster of deflation.
The biggest data point of the month was undoubtedly the increase in consumer confidence that we witnessed on May 26, 2009. Economists had estimated that the index would come in at 42.9, but the actual number was 54.9. The market rallied strongly on this news, hoping that this survey was an indicator that consumers were feeling better about the economy and may be preparing to increase their spending once again. These were all positive developments for the economy, but we aren’t ready to let our guard down just yet. Before we can sound the all clear we would like to see more improvements in the data, and not just “whew, that wasn’t as awful as we thought.”
New Bull Market Unlikely
Based on technical analysis, it still seems unlikely to us that we have entered into a new bull market. Our recent research has focused on the characteristics of the stocks that led the rally which began March 10, 2009. On average, the stocks having the highest short interest, the worst analyst ratings, the least institutional ownership, and the poorest performance during the pullback that ended March 9, 2009, have been the stocks performing the best since the most recent bottom. It’s rare in a bull market that the stocks leading the market lower are the ones that lead it back.
However, often in bear market rallies stocks priced at their liquidation value and appearing on the verge of insolvency see dramatic price increases. The hope is that these companies will make it through the downturn and that their share price will climb above their liquidation value. The stock prices of high quality companies have risen in tandem with the market, but not to the extent of lower quality issues. To be more constructive in our view of the market, we would like to see leadership from the highest quality stocks and not just a rebounding of the junk from the brink of bankruptcy.
The Volatile Bear
The case for a bull market is hampered by the extreme volatility seen in the most recent downturn and subsequent rally. From February 9, 2009 to March 9, 2009, the S&P 500 Index fell 22 percent. In the following month, from March 9, 2009 to April 9, 2009, the S&P 500 Index rose 27percent. Market swings such as this are characteristic of bear markets: fast, violent declines followed by fast and impressive rallies.
Bull market beginnings, however, are typically met with little fanfare. Most often, the weeks preceding a new bull market are characterized by slow, modest declines as selling pressures subside, followed by equally slow, modest returns as investors gradually begin to increase their equity exposure.
Lack of Trading Volume
The other thing that is conspicuously missing from this rally is trading volume. The dawn of a new bull market is marked by an approximate 20% increase in trading volume. In bear market rallies, however, increases in trading volume are rare. In fact, most bear market rallies occur with significantly less volume than what was seen in the preceding decline. When the weekly volume for the S&P 500 is analyzed, it is evident that the current rally has had some strong spurts, but on the whole the volume is not as strong as the volume that was seen in late February 2009 and early March 2009. This gives us pause that the large institutional buyers, those that can truly impact trading volume, are remaining on the sidelines waiting for a better opportunity to enter the market.
Outlook
We continue to see obstacles to domestic growth in 2009. In markets such as these we believe that our portfolio strategy should be active and not passive and that there are opportunities to be found. Many international economies with fewer challenges than the US have done well in 2009. Allocations to corporate investment grade and high yield bonds have also been beneficial as investors’ appetite for risk has returned. Returns may not come from the traditional sources, but they are certainly available for the discerning investor that is willing to take a different approach to investing. We are monitoring dollar valuation and inflation carefully and will be building inflation protection strategies into our portfolios as economic conditions warrant.
As always, we appreciate the trust you place in us as your financial advisor. We are only a phone call away should you have any questions or concerns.
Broad Street Capital Advisors, LLC