Sensible Investing

The overall market sentiment now is very similar to that of the previous quarter.  There is still plenty of skepticism around, driven by uncertainty of this recovery and the very fact that market gains happened so extraordinarily quickly.  We are still climbing the wall of worry, with many investors remaining on the sidelines convinced that we are in the bear market rally (which from the contrarian point of view is the ideal market condition).  Similarly to the last quarter, the coming earnings season is going to be hugely important.  Q2 (as well as Q1) results exceeded expectations, and of course the markets are driven by the earnings.  If this trend continues, so will this rally.

There are also important differences between current and previous quarters.  Major economic indicators improved significantly.  For example, then the economy was still contracting (although at a lower rate of decline) and housing prices were falling.  Now it is a virtual certainty that GDP rose in Q3 and the housing market is stabilizing.  Not everything is roses, of course.  Just a few days ago, manufacturing, consumer confidence, and unemployment reports were worse than expected.   This recovery, as any other, will have its hurdles and the markets could get bumpy.

The market action over the last two years confirmed my long-held belief that market timing is impossible and that one has to stay invested to participate in sharp upward moves.  Chances are, someone who sold on the way down is still on the sidelines waiting for a good market.  And they often buy after the market has already been good.

While everyone seems to be in agreement that the recession is over (or nearly over, anyway), the debate du jour is about how vigorous the coming recovery will be.  The prevailing opinion is that it is going to be slow and shallow, given high unemployment and poor consumer spending.  Here is a different view, which argues that prevailing opinions are usually wrong and given the depth of the recession we just had, the recovery will be anything but shallow.

There is an old saying on Wall Street that bull markets climb the wall of worry.  With the markets up 50% from the March lows, there are plenty of worries to go around: uncertainty about strength of the recovery, fears of double-dip recession, and the very fact that the markets went up so much in a short period of time.  On top of that, we are about the enter the statistically worst month of the year, September.  No wonder that there is a lot of talk about upcoming correction.

From the contrarian point of view, that is exactly why it won’t happen, or if it does happen, it will be relatively mild.  This rally certainly has fundamentals supporting it, in the form of improving manufacturing reports, durable goods orders, and even housing.  After severe spending cuts, pent-up demand for various goods is apparent today, especially on the business side.  A good example of this is IT industry, even though this particular pent-up demand is amplified by the upcoming release of Windows 7 operating system from Microsoft.  This week, Dell and Intel both increased revenue outlooks for the rest of the year.

The two admittedly very important missing links in this recovery are still anemic consumer spending and high unemployment.   The question now is whether employers cut too many jobs during the crisis and thus created pent-up demand for work.  There is some evidence of that in recent reports that new and continuing unemployment claims are stating to fall.  If that is the case, expect the markets to continue its climb up the wall of worry.

Today, the markets broke through psychologically important barriers of 1,000 for S&P 500 and 2,000 for Nasdaq, levels not seen since last fall.  Despite the gains, both indices are still about a third off their highs reached in the fall of 2007.

For complete details, look at this Wall Street Journal article.

We are just a few days into the second quarter earnings reports, and so far they have been good.  We have seen better than expected announcements from bellwethers such as Alcoa and Johnson & Johnson, while Goldman Sachs and Intel reported blow-out earnings.   On top of that, the Fed raised its economic forecast for the rest of the year and for 2009, something that hasn’t happened for a while.

All these news drove the market considerably higher today.  The bulk of earnings reports is still ahead, but so far it appears that the recovery is still on track and that the probability of a market consolidation is declining.