It has been a roller coaster year for stock indexes. In June, The Dow Jones Industrial Average was up 22% year-over-year from June 2009 but closed the month off with new lows for the year. The Dow started 2010 at around 10,000, crept up to over 11,000 in April and then went back down below 10,000 by June. Movement in the S&P 500 over the year was similar to the Dow, as the S&P was up almost 20% from June 2009 to June 2010 and sat at just over 1,000 at the end of June, down from higher levels in April and May. Analysts are split on where indexes are headed for the rest of the year, with some saying that the outlook is bullish and others saying we’re in for a double-dip recession and the markets are headed lower. And with differing predictions come different ideas on what markets will trade off of for the rest of 2010.
Recent economic reports and news coming from the Federal Reserve point to possible signs of a double-dip recession. New home sales for May were down 33% after government tax credits for new home buyers ended in April. And the short-term boost given to employment numbers by census jobs is gone too. At its June 23 meeting, the Federal Open Market Committee (FOMC) said “Financial conditions have become less supportive of economic growth on balance,” and the pace of economic recovery was likely to only be moderate due to weakness in employment, depressed housing numbers and sinking growth abroad.
Shawn Hackett, president of Hackett Financial Advisors, says stock indexes are likely to trade off of continued deterioration of economic activity for the rest of the year. “Housing and leading economic indicators are showing a deceleration of economic activity and that suggests that the stock market’s current earnings expectations are too high and they’re going to have to recalibrate stocks lower to reflect a much more modest economic environment. That’s going to continue to drive the market to get much more bearish,” he says. Hackett expects a bear market to reemerge by the end of the summer, with equity markets ending the year lower (the Dow at 7,500-8,000 and the S&P at 800-850).
Another stock bear, Addison Wiggin, executive publisher, Agora Financial, agrees that disappointing economic news will drive stock indexes lower. He says stocks are headed for an 18-month bear market, and before it ends the Dow and S&P 500 will both take out the 2009 lows (6,470 in the Dow and 666 in the S&P). “We’ve passed through a historic sucker’s rally that will end this year,” he says. “It looked like the economy was improving in the headlines [during] the spring and that helped contribute to people feeling optimistic about the stock market, but that headline optimism is going to fade before the end of the summer. When people come back in September, we’re going to see a pretty tough fall.”
Some analysts, however, expect economic conditions to improve and thus stock indexes to head higher through the end of the year. Jeffrey Friedman, senior market strategist at Lind Waldock, says housing numbers should improve and low interest rates will help the market go higher in the fourth quarter. “I’m not in the camp of the double dip recession; 1,000 [in the S&P] should hold,” Friedman says, adding that if employment increases at a rate of 50,000 to 100,000 jobs per month, he expects 1,180-1,200 in S&P and 11,000 to 11,200 in the Dow by the end of the year. That may be a tall order as non-farm payroll growth has slowed and would have been flat to negative in the spring if not for part time census hires.
Low interest rates will be key to equities going higher through the end of the year, says Alan Bush, senior financial futures analyst at Archer Financial Services. “This is only a correction in a multi-year bull market. The low interest rate environment will dominate and overpower all the bearish influences, both domestic and international, to take stock indexes higher this year and over the next several years,” he says. At the end of 2010, he predicts the Dow to be at 10,700, the S&P at 1,148 and the Nasdaq at 1,985.
Larry Levin, president of Trading Advantage.com, expects equity markets to continue to move higher on low volume for the rest of the year due to government stimulus (see “Holding back the tide,” below). “We’re in the midst of a correction. It’s not a bear market. The market should be in a bear market, and the economy would make you think it should be in a bear market, but the government intervention is preventing the stock indexes from moving in the same direction as the economy,” he says, adding that he expects the S&P to be at 1,200, the Dow at 11,500 and the Nasdaq above 2,100 by the end of the year.
What’s moving the market?
Analysts say economic news, earnings and interest rates will move stock indexes for the rest of the year.
“It’s going to be about earnings. That’s what we’ve rallied on. It’s not about a ton of profits, it’s about cost-cutting and that’s where the profits have come from. If [companies] have good earnings, we’ll see the market continue higher,” Levin says.
Bush says the market will be fueled by record low interest rates the rest of the year. “Many traders are focusing too much of their attention on domestic and international problems such as the sovereign debt issues in Europe. Historically low interest rates will solve all problems, at least in the short run,” he says.
On the other hand, Friedman says that the sovereign debt crisis in Europe and the question of whether the euro will survive, along with U.S. employment numbers, will affect the market. “If you can get employment to go up, you’ll get more confidence,” he says.
The speculation of a double-dip recession itself could also move the market. “We’re going to continue to get scary data out of the housing market and unemployment will pick back up and those numbers are going to be important because it’s going to smash the optimism we’ve been seeing. We’re going to see strengthening gold price[s] and probably rising oil and those two numbers are going to wreak havoc on stocks,” Wiggin says. “All of this uncertainty about the euro has the ironic role of pushing people into the dollar and Treasuries, which sometimes actually bolsters stocks on NYSE when people get nervous about Europe. If there isn’t the headline optimism of a recovery, then any kind of bad news coming out of Europe is going to be bad news for U.S. stocks.”
Bush, however, is bullish. “Buy into any negative news where sell stops might be hit [and] use that as an opportunity to establish long positions. We’ll see some recovery gains and the bull market reasserting itself this summer and fall,” he adds.
Friedman, who also thinks stock indexes are headed higher, says traders should invest in commodities and gold. “Commodities should go up. China will be a contributor to buying corn, wheat, and maybe copper. Of all the commodities, you should be long gold. Gold’s going higher in the next two to three years,” he says.
Levin says, “Even though the market’s going up, you still want to pay intelligent prices for investing vehicles. You have to be buying on the way down. When the market’s dropping, investors should get involved. The best investing method is to buy on the way down.” For the rest of the year, he says investors should trade institutional banks and brokerages and tech stocks and avoid retail and energy stocks.
Not your average bear
Some analysts point out that this recession is different from past recessions and the recovery period will be different too, which will have an impact on stock indexes.
After all it is easy to forget that less than two years ago we were looking at a total collapse of our economy and many experts were comparing what was going on in the economy with the Great Depression.
Hackett says that past recessions have been followed by V-shaped recoveries, but “We’ve never had this kind of debt to GDP before. We have an economy that’s trying to come out of recession and grow at a time when debt is too high. Instead of the money creating credit to allow for more spending and more borrowing, the exact opposite has been happening. That growth is being used to pay down debt instead of [increasing] economic activity. [The recovery] is going to be a W-shaped pattern,” Hackett says.
Wiggin compares the current economic environment to the economic collapse of 1929, when the market didn’t fully recover until 1954 (see “History repeating?,” below). “We’re in a similar phase where you have periods of optimism and pretty good rallies but the underlying fundamentals of the economy haven’t been repaired yet. If you want to trade those rallies, you have to recognize that the historical trend that we’re in right now doesn’t look good for the long run,” he says.
And if we are in an environment more akin to depression than recession, all those typical run of the mill recession anecdotes and patterns we follow may not be useful tools.
Wiggin is following the basics.
“Things like the housing market and the employment picture are going to be very important to the overall psychology of the market. Macro trends right now are more important than the fundamentals of any company that you might be looking at,” he says.
“We’re still suffering from spending way more than we can afford to spend and until we can figure that out, U.S. stocks are going to suffer right along with the economy,” Wiggin adds.
Hackett agrees that the risks that the U.S. and global economy have are something that we have not seen before. “We have a higher degree of risk than we’ve had for an extended period of time. No one should be looking for a big return. Be in a cash-building mode, [look] for real safety and preservation of capital. An investor needs to understand that we’re in a bear market, sideways volatile trading pattern and one needs to trade that reality and not just buy and put away and hope for the best. You have to be willing to be more active,” he says.
Where are we now?
Seeing that analysts have described equity markets recently as displaying characteristics of a bear, bull, correction to a bear and correction to a bull market, traders need to be on their toes. The economic crisis, debt crisis (both here and abroad) and unprecedented economic stimulus are pretty significant wild cards to measure, so it is no wonder there is a schizophrenic element to both market activity and analysis.
It is hard to know where you are going when you can’t even agree on where you are, but that is the case with equity markets today (see “Bear or bull,” below). And from what we see and hear, that uncertainty and volatility doesn’t appear to be changing any time soon, so traders need to adapt to it.