It’s a new quarter.
Do we know any more about the trend in the stock market and the economy than we did at the start of last quarter
Well, actually a little bit. I don’t think we’re at “Bet the farm” certainty, but figuring out the trend isn’t quite as confounding as it was three months ago.
Partly that’s because three months ago the market and economy were truly baffling. When the bar is so low, “Mildly conflicted confusion” is a big improvement.
But partly it is because the trends in the financial markets and the economy actually seem reasonably clear as we head into the fourth quarter.
Let me start with a quick survey of the bad old days of July 1 and then move into my list of what we know and what we don’t as we investors try to figure out how to navigate the fourth quarter of 2010. And because I like crawling out on a limb and then taking my Husqvarna to it, I’ll give you my best guess-timate on how certain it is that we really know what it is we think we know.
Remember where the market stood on July 1? Stocks had been caught in a pretty steady downdraft since the April 23 high at 1217 on the Standard & Poor’s 500 index. The market would, in fact bottom, on July 2 at 1023, then rally to a high of 1128 on August 9 and then tumble again to a low of 1047 on August 26.
For much of the quarter it looked like the rally that began in March 2009 was over, kaput, stick-a-fork-in-it done. With the July and August rally ending on August 9 at a high so much lower than the April high at 1217 and with the market seemingly determined to head for an August low below the 1023 of July 2, it sure looked like we were headed for one of those lower high/lower low patterns that tells you even worse stuff is on the way.
But instead the market pulled up way short of setting a lower low in August and then proceeded in September to move above the August high at 1128. And suddenly what looked like a high probability of a move from a bull to a bear market looks now like it was just a correction.
Which brings us up to the end of the third quarter. And my survey of what we think we know for the fourth quarter.
- The technical trend in stock prices is pointing very solidly up. On Tuesday September 28 the Dow Jones Industrial Average moved to just 3% below its April 26 high. In the last few days other indexes have moved up to confirm the Dow trend. The NYSE Composite and NASDAQ Composite indexes, for example, are both in up-trends on rising volume. The Russell 2000 Small Cap index has closed above its August high. The Dow Transportation index rose on September 287 to its highest close in four months. That’s important confirmation for the move in the Dow Industrials since transportation stocks move up when investors think the economy is improving. There may be bumps along the way from, say, third quarter earnings reports in October but the trend say stocks will be higher at the end of the year than they are now. Certainty that this trend is what we think it is: 80%.
- The economy is strong enough so that a double-dip recession isn’t a worry and even consumer buying is, if not strong, better than expected. Here the most recent data comes from shipping companies, FedEx (FDX), United Parcel Service (UPS), and Delta Air Lines (DAL). All are reporting a pickup in traffic to stores that signals a better than expected holiday shopping season. Now we’re not talking dancing in the streets enthusiasm, mind you. Delta, which carries more air freight than any other U.S. airline, told Wall Street that it projects a “perfectly decent” holiday season,. FedEx, the second largest package shipping company in the world, calls its shipments “solid.” Retailers do indeed seem to be restocking inventories in anticipation of a decent holiday shopping season. Toys R Us even reports that it will hire 45,000 holiday workers, 10,000 more than last year. (Temp jobs granted but still the company is hiring. And hiring at above the levels of last year.) Projections from the retail group at Deloitte say that holiday sales from November through January will climb by 2% from 2009 levels. Hardly a bonanza, you might say, but I’d remind you that holiday sales rose by just 1% in the 2009 season. A decent holiday shopping season would be good for investor morale and for stocks. Certainty that this trend is what we think it is: 70%.
- Businesses keep on ordering capital equipment. Orders for capital equipment, the stuff that businesses buy to expand or improve their businesses, rose 4.1% in August, according to data from the Commerce Department reported on September 24. Orders for non-defense capital goods excluding aircraft, the most useful measure to watch if you’re trying to predict the pace of business investment, has now climbed at s 15% annual race over the last three months. That’s down from the 24% annual rate for May, June, and July, but certainly isn’t the kind of drop that you’d expect if business were expecting a double-dip recession. Certainty that this trend is what we think it is: 70%.
- Short-term interest rates are low and they’re going to stay low. Longer-term interest rates are low and they’re likely head lower in the quarter. The Federal Reserve has made it very clear that it thinks there’s no need to fight inflation in this economy and that it will bias monetary policy toward increasing the economy’s growth rate. That means no increase in the short-term rates controlled directly by the Fed and at some point a return to buying Treasuries to depress longer-term interest rates. Lower interest rates, all else being equal, are good for the economy and for stocks—in the short run. Certainty that this trend is what we think it is: 99%.
- The official unemployment rate is unlikely to significantly budge from its current 9.6% rate in this quarter. Even if the job market picks up, there are more than enough discouraged workers looking to re-enter the workforce to keep the unemployment rate high until way into 2011. Government layoffs are a huge factor in the lack of progress: states, and cities are cutting their workforces as lower tax revenues lead to budget deficits. But private sector employment is picking up. Private payrolls grew by 67,000 in August and are projected by economists to have growth by 50,000 in September. That’s enough to give investors (if not consumers) hope that the jobs picture is headed in the right direction, albeit at a horrendously slow pace. It’s certainly not enough to produce economic growth of much better than 2%. That’s probably enough to boost stocks in the fourth quarter since expectations for growth are so low and fears of a double-dip still so high. But it does make me worry about 2011 when 2% growth is likely to be greeted with exasperation rather than relief. Certainty that this trend is what we think it is: 80%.
- Housing prices are the other big drag on the economy. If you don’t have a job (or are afraid of losing one) and the price of your house is falling, you just aren’t going to rush out to the store. That’s especially true when the number of foreclosures is still rising. Lenders foreclosed on 95,000 homes in August, a record. Although the number of initial notices of default dropped by 30% in August, it will take some time before that trend translates into fewer foreclosures. And right now the tide of foreclosed properties on the market is a major force in preventing any recovery in home prices. There’s some evidence that housing prices may have bottomed, but there’s no reliable projection for how long home prices will bump along the bottom. I think this picture takes most of the growth out of a substantial piece of the U.S. economy—construction, home improvement, homebuilders, white goods, and construction machinery. And that’s one more reason to think that while growth will be decent enough in the fourth quarter, stocks and the economy will be challenged again in 2011. Certainty that this trend is what we think it is: 50%.
- Every body knows the dollar is in the tank so a falling dollar isn’t going to arouse a lot of fear among investors. And in the fourth quarter it’s even likely that against the euro and maybe even the yen, the dollar won’t be quite as big a dog as you’d expect from looking at our budget deficit. (More like a Labrador than a Great Dane) That’s because in the short-run of a quarter, the euro crisis is going to continue to make that currency look even riskier than the dollar and because the Japanese government, out of ideas for reviving the Japanese economy, will intervene in currency markets to weaken the yen. The dollar will, of course, continue to weaken against the currencies of commodity-producing economies such as Australia and Canada and that in itself will boost commodity prices. Gold will continue to climb in the quarter on the general turmoil in the market for the world’s big currencies. Certainty that this trend is what we think it is: 70%.
None of this means that there aren’t potential surprises lurking in the quarter. For example, a slowly simmering euro crisis could worsen enough to present financial markets with Greece II. That would produce panic selling of financials again. I think the likelihood of that is small for the fourth quarter but very real for the out years of 2012 through 2014 when several euro economies, including Greece’s, face big refinancing bubbles.
Beijing could make a major mis-step and cut back too hard on growth in order to slow bank lending. But again I think that’s more of a worry for 2011 than for the fourth quarter of 2010. Same with the U.S. budget deficit and Japan’s no-growth economy and aging population.
Enjoy the relative clarity of trends in the fourth quarter. At this point 2011 looks like a return to the murk.
Full disclosure: I don’t own shares of any company mentioned in this post in my personal portfolio.