Economic Momentum Is Increasing
Expect A Marathon, Not A Sprint
Stocks Are Leading The Way Back
Black Swans Do Exist
Index Funds Shine
The Bottom Line This Week
Somethingodd is occurring on the way to Armageddon that the army of doom and gloompredictors never expected. Instead of suffering a meltdown, Wall Street andMain Street are throwing parties.
We’llbe the first to admit that the gaiety isn’t setting any records. Nevertheless,economic growth is a healthy 4% and may be somewhat higher. We won’t know untilthe Fed shakes the numbers out after the first quarter ends today. We shouldget the verdict next week.
Asto the stock market, nobody has anything to complain about. Since ournewsletter was published last month, the Dow and the Nasdaq went up aheartwarming 5.7% and 7.9% respectively. Those are nice gains in anybody’sbook.
EconomicMomentum Is Increasing
Thebig question now is whether or not more good news is on the way, or if theparty is over.
Asfar as the economy is concerned, we have little doubt that it will continue togrow. The low end of the predicted range for the year is 2%, but that levelseems overly pessimistic to us. The high end is about 4.2%. If we had to choosebetween them we wouldn’t take the average. Considering how much momentumalready exists in the economy, we think the high 3% area will win the office pool.
Thebiggest engine for growth is consumer spending, which is moving up strongly.Tiffany’s, Williams-Sonoma, FedEx, and dozens of other firms are reporting thatsales and profits are exceeding expectations. It’s a solid trend that feelslike a real turnaround, not a seasonal blip.
However,there are some concerns about the staying power of consumers, primarily becausethe unemployment rate is high. We think the worrywarts are looking at the wrongnumber. If 10% of the adult population is out of work, it means that 90% stillhave jobs. That’s a lot of shoppers. Their purchases are more than enough tokeep the economy moving.
Businessspending is also starting to rise. That’s to be expected because consumers aredepleting the inventories that built up during the recession. As warehouseshelves continue to empty, suppliers will need to replace what’s being sold.That process will take several months, and it will contribute a great deal togrowth.
ExpectA Marathon, Not A Sprint
Allin all, the economic outlook is good. However, there are still some impedimentsto growth that are likely to keep the recovery on medium heat rather than on afast boil.
Thebiggest problem is the credit crunch. Instead of using the Fed’s bountifulbillions in bailout funds to jump start the economy, banks are holding ontomuch of the money. They are using it to make up for the bungling losses theychalked up during the recent bust.
Manypeople think the financial geniuses should have been left to deal with theirown mess, but the government felt otherwise. Come to think of it, the bankers arethe government, or at least an influential part of it so we should not besurprised that they voted themselves out of trouble.
Manybanks are also building up a war chest for a merger and acquisition spree thatappears to be on the way. Whatever the reason for their miserly attitude, itcan be tough to get a business loan.
Inaddition, rising taxes are a concern. Nearly all the Bush tax cuts will expireon December 31. To make matters worse, over $2.8 trillion (that’s with a “t”)in new federal taxes will start to be phased in. The double hit will be a deadweight on nearly every part of the economy.
Lastly,investors worry that interest rates are likely to rise. The Fed is doing itspart to hold them back, but it doesn’t have the final say. Because debt risksare increasing, the enormous private market for bonds is starting to push ratesup on its own. If the cost of money increases by very much, it will have anegative effect on the housing market, auto sales, and many other parts of theeconomy.
StocksAre Leading The Way Back
OnWall Street stocks are enjoying stellar growth. Since this time last year whenthe bull did an end run around the bear, the S&P 500 has gone up 73.4%. Itwas a thrill to watch.
Someanalysts believe the upturn was just an oversized dead cat bounce that was tobe expected after the equally oversized plunge from late 2007 to early 2009. Wemight be inclined to agree if the economy was going nowhere. Since that’s notthe case, we think stocks have further to rise.
Stockmarket history also suggests that prices will go higher. The old adage that”bull markets climb a wall of worry” is true. As we mentioned above, there isno shortage of concerns that make investors nervous. Typically, bull cyclesdon’t end until investors are convinced that they will go on forever.
Onecaution is in order. No rising trend goes very far without stumbling. The stockmarket is no exception. After the recent impressive gains, we think a 10% to15% pullback is likely, after which the market should resume its upward path.
BlackSwans Do Exist
Until1770 everybody took for granted that all swans are white. No one evenconsidered the possibility that a black swan could exist. However, naturalistswith Captain Cook found them when they visited Australia.
Evenwhen the good captain brought a black swan back to England, many people werenot convinced. The bird looked just like a regular swan that someone had dyedblack. That’s how difficult it can be for people to accept something totallynew.
Ablack swan is an event that no one would expect. When they suddenly appear,they can have serious consequences. Pearl Harbor was an example. The terroristattack on 9/11 was another. When they happened, stocks plunged, and the economynearly followed them down.
Weare bringing up the issue of a black swan event now because the world isbecoming a volatile place with rising tensions. A big enough shock could upsetthe fragile balances. For that reason, we urge you once again to place stoploss orders on all your stocks. You have insurance on your life, your house,and your car. You should have stock market insurance as well.
IndexFunds Shine
Whenthe stock market has a good run, index funds usually outperform mutual funds.That’s because index funds are always fully invested in the group of stocksthey follow. As a result, brokerage and management fees are almostnon-existent. The low costs mean that nearly all the gains an index fund makesgo to its investors.
Mutualfunds, on the other hand, always keep some money out of the market where itcan’t benefit from rallies. Mutual funds also have high research and managementcosts. Of course, their trading fees are also high.
Thebroad market advance we are having now is ideal for index funds. Our favoriteis the iShares Dow Jones Select Dividend Index (DVY), a blue chip fundthat tracks the Dow Industrial Average.
Moreaggressive investors may prefer the PowerShares Dynamic Small Cap Fund(PJM). http://finance.yahoo.com/q/bc?s=PJMThis ETF tracks the Dynamic Small Cap Index that consists of approximately 200companies. Last March the fund traded for $10.86. It has since gone up to$20.22, an 86.2% gain.
Youprobably noticed that over the past year the small cap PowerShares fund barelyoutperformed the blue chip iShares fund. During normal market conditions wewould expect the small stock margin to be greater.
Aftera deep stock market slide, however, investors favor safer blue chips. Laterthey turn to small caps. We think the latter are coming up to bat now andshould have a good 2010. *
TheBottom Line This Week
Boththe economy and the stock market are doing well. Stocks are leading the race bymore than a few laps, and they may be due for a correction. The economy is thetortoise in this race, but it should have its usual staying power.
Wedon’t see any black swans on the horizon, but nobody ever does. The way to dealwith their unpredictability is to go about your normal business but takeprecautions against shocks. In stocks, that means you should put stop lossorders on everything.
Lookingahead, we think the iShares Dow Jones Select Dividend Index willcontinue to make gains. The PowerShares Dynamic Small Cap Fund may doeven better as investors feel more comfortable giving up some safety inexchange for a shot at higher performance.
UntilNext Time
The AIA “Advocate ForAbsolute Returns”, a publication of The Association for InvestorAwareness, Inc., tracks market trends, industry news, the SEC, global trade andfinance and Washington developments for you because they affect yourinvestments. But who doesn’t? Many sources report these issues as abstractfacts. We feel that’s not enough. The AIA Advocate’s job is to warn you ofwhat’s important and how these developments translate to ground-level forcesand threats that directly affect your wealth as well as your current investmentopportunities. Not just information, but information you can use. Until nexttime…
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