by Hal Eddins, Capital Investment Council
A few months back, a client asked us how we would “know” when the equity markets had gotten “better”. Our reply was that at some point, people would be more afraid to be out of the stock market as opposed to being afraid to be in it. The public’s outlook on stocks has improved since the market’s rally off of the March 6 lows. Over that time, volatility and fear levels have dropped from a reading of 55 for the VXO on March 6th to a recent level of 26.
In early March, the Dow was barely 6500. Just three months later and we see the Dow at 8800. It’s ironic that some now feel that the “all clear” has been sounded and it’s time to invest heavily. I won’t argue that stocks can still be considered inexpensive, especially compared with their 2007 levels. However, the major averages have still rallied 33% in twelve weeks, and we may be due for a pause. Note the use of the qualifier “may”.
I feel the market could have the potential for a 7% to 9% correction over the next few months, but I also see the potential for the Dow to reach 11,600 in the next few years. The question is not so much the destination but rather the route we take to get there. In my opinion, a near term key level for the Dow is 9050. A close over that level could likely set into motion the beginnings of the longer term rally I spoke of above. Again, the sticking point may be the timing. Markets have run into resistance levels at a time when they are also a bit extended and overbought.
The best markets have a tendency to get overbought and stay overbought. For an example, think back to the big run off of the bottom in March 2003 as the US invaded Iraq. By May of that year, the S&P had reached an overbought status; however, the market defied the odds, stayed strong through the remainder of the year, and finished with a 26% gain.
No matter the outcome, markets have enjoyed a solid three months. The market could be signaling a recovery in the overall economy over the next 12 months. At Counsel, we are monitoring our favorite companies. We are circling potential targets and the prices we would be willing to pay for them.
I try not to delve too deeply into politics, but the large amount of spending of “our” money by the current administration makes me take a second look at the deficit. To gain some perspective, let’s look back to the end of the Reagan Era. In 1988, our national debt was 41% of gross domestic product. Fast forward 20 years to George W. Bush’s last year in office and we see that debt is still 41% of GDP. So far so good, but the government’s current rate of spending shows the debt to GDP ratio to potentially soar to 80% by the end of President Obama’s time in office.
Some markets are already displaying signs of worry over excessive US government spending. Perhaps the most visible sign is one that we see and use everyday: the price of a gasoline. Gas has rallied sharply over the last three months. While the world economies have seemed to strengthen, I feel it is unlikely that they have strengthened enough to support oil at $70 a barrel. Supply and demand don’t seem to be doing a good job of forecasting the current action in commodities. Some market participants appear to be acting in a manner that runs counter to common sense.
One of those market participants will likely prove to be China. In addition to their large consumption of oil, China has developed a taste for gold as well. In fact, China has doubled their gold holdings over the last six years. That may well account for the bulk of the gold’s rise from $450 an ounce in 2005 to our current level of $964 China is attempting to hedge their large exposure to the U.S. dollar; as the dollar drops, gold tends to rise. How does this story end? I’m asked by many if gold is a good investment. The answer is not simple. Gold has doubled in the past four years, and gold tends to shine when other asset classes are floundering. There are hyper-inflation fears out there. As the general economy continues to recover, we may actually see gold drop as much of the move has already been discounted.
What about that old maxim “sell in May and go away”? Should we be practicing that this year? Maybe not. Historically, the best seasonal periods for stocks tend to be the six months from November to April. The problem currently is that the “other” six month period (May through October) has proven to come into its own during bear markets.
Since 1929, there have been 14 bear markets. In 12 of those 14 markets, the S&P 500 has had an average rally of 12% during the May through October period. Some fund managers were caught short (literally) by the market’s sharp rise in the last three months. These managers have cash on hand and are eager to invest it less they miss out again. That could potentially make our market pullbacks shallow during the summer and early fall.
Disclosures:
Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The actual characteristics with respect to any particular client account will vary based on a number of factors including but not limited to: (i) the size of the account; (ii) investment restrictions applicable to the account, if any; and (iii) market exigencies at the time of investment. Capital Investment Counsel reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. The information provided in this report should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in an account's portfolio at the time you receive this report or that securities sold have not been repurchased. The securities discussed may not represent an account's entire portfolio and in the aggregate may represent only a small percentage of an account's portfolio holdings. It should not be assumed that any of the securities transactions, holdings or sectors discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. All recommendations within preceding 12 months or applicable period are available upon request.
Capital Investment Counsel is a registered investment advisor. More information about the about the advisor including its investment strategies and objectives can be obtained by visiting www.capital-invest.com.
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