Stocks now appear poised to begin a long-awaited correction. Since the beginning of June, the S&P 500 Index has lost more than 3% and continues to struggle as the advance-decline line deteriorate, new highs decline as new lows increase while mutual fund-flows have ebbed. But like I’ve said before, stocks won’t succumb to a bear market – at least not yet.
“A classic monetary squeeze is not occurring, which typically precedes a bear market for equities. Corporate earnings are adjusting to a slower growth environment, but will continue to expand at a healthy clip this year. Foreign economies remain strong and will outpace the United States in 2007. Should the mortgage market continue to unravel, I expect the Bernanke Fed to start cutting interest rates, which will help to put a floor on the market. Also, as the Fed is well aware, cheaper credit will also encourage hedge funds and private equity funds, today's surrogate bankers, to buy busted mortgages, a boon for financing, acting as a stabilizer for distressed housing.”
That’s what I wrote several weeks ago and I stand by the same observations today.
Another major plus for this bull market is low interest rates.
The big spike in bond yields earlier this month was a short-term aberration in the five-year trading range we’ve seen for the benchmark ten-year Treasury. The market got spooked about a rapidly recovering American economy this quarter and rising inflation. Facts are, however, the economy is still sluggish with a host of data over the last week pointing to slow growth, particularly in housing, durable goods orders and consumer sentiment. This is not the kind of economic data that precedes a monetary squeeze or a fresh bond bear market.
One thing for sure, however, is that foreign markets are indeed growing much more quickly than the U.S. economy. And those central banks are doing the right thing, raising interest rates, but grudgingly. The Fed does not set monetary policy for China or Europe; the primary indicators for the Federal Reserve are employment trends, inflation and housing. So far, there’s major trouble in housing.
Bottom line: Stay invested in stocks because they’ll outpace bonds again over the next 12 months, barring a geopolitical crisis. Stocks are still consolidating and might even plunge this summer. But by the time we hit earnings season in October, I’m expecting another major rally as the Fed relents by cutting interest rates, the dollar declines and the economy starts to recover.
Keep holding some cash…
I’m flying back to Montreal today from Zurich. I’ll have some European observations for you in tomorrow’s post.
