It was bound to happen eventually.
Maybe it was just too much too fast.
[img]648|left|||no_popup[/img]
Since hitting its lows in early March, the S&P 500 – the real measure of industrial prosperity – has shot up nearly 47 percent. At the pace it was going, it looked like the market was poised to return to pre-recession levels, as if nothing had happened.
Conflicting Signs
Something did happen; and Wall Street investors are beginning to do a reality check.
Seventy-seven banks have failed so far this year. Hundreds of billions have been spent bailing out financial institutions once considered the bedrock of our economy. The tidal wave of home foreclosures has continued to inundate the housing sector, and unemployment is still climbing.
The stock market has had a spectacular run. With the manner in which investors have flocked back to Wall Street, you have to wonder what they’ve been smoking.
Investors may not just be pausing to digest their gains and book their profits. They may be pondering how far the rally can go when the economy is still showing significant signs of underlying weakness.
Growth in the Japanese economy for the three-month period ending June 30 should have been a positive indication that the global implosion has started to slow. Investors were apparently soured because instead of growing at the predicted 3.9 percent annual rate, Japanese domestic output missed the mark by two-tenths of one percent.
According to several surveys, confidence in the global economy surged to a 22-month high in August. Friday’s sell-off, which has been extended into this trading session, appears to have been triggered by an unexpected sharp drop in the Reuters/University of Michigan consumer sentiment index. The weaker-than- anticipated consumer sentiment reading followed a Commerce Department report that showed sluggish retail sales in July.
[img]649|left|||no_popup[/img]
There are positive indications that other sectors of the economy, such as housing and manufacturing, are showing signs of progress. Because consumer spending accounts for more than two-thirds of the economy, most analysts agree that it is not possible to have a sustained recovery until consumers start spending more freely.
More Conflicting Signals
The lag in consumer spending was underscored by a report last week from Wal-Mart. The nation’s largest retailer reported that sales figures at stores that had been open for at least one year fell between April and June. Adding doubt to the equation, home improvement retailer Lowes Cos. said that its sales plummeted 19 percent for the same period.
While energy companies like Exxon and BP may be buoyed by the rise in oil to $66 per barrel, consumers are feeling squeezed by gasoline prices that have pushed the national average above $2.70 per gallon. Although these prices are a far cry from those seen last summer, it’s been enough to put a further damper on consumer confidence.
A number of informal surveys have also shown that the world’s biggest pension funds have not regained their confidence in stocks as the best long-term investment. Despite the steepest stock market rally since the 1930s, several funds including CALPERS (California Public Employees Retirement System), which manages retirement funds for teachers and public sector employees in the Golden State, have trimmed their holdings.
Historically, late August and September is a difficult time for the stock market. With the economy still in flux, investors are now likely waiting for third-quarter guidance and earnings before they make new major stock purchases. This may result in a further softening of stock prices as investors consolidate their holdings.
Given wrenching dislocation experienced in nearly every sector of the economy, it’s simply unreasonable to expect a rapid return to the former bull market conditions. Far too many formerly unshakable institutions have been shaken to their core, and the jell-o is still jiggling.
Past experience has also shown that no market, no matter how strong, will continue to rush skyward without a breather for corrections. This market is no different. In the final analysis, it may prove even more vulnerable than it predecessors.
I’m not suggesting you stay away from the stock market. Invest if you must.
Just keep one eye on the exit.
Maybe next time when these blokes start to falter from their own largess, we won’t be so quick to open our checkbooks to save them.
John Cohn is a senior partner in the Globe West Financial Group, based in West Los Angeles. He may be contacted at www.globewestfinancial.com