Insights & Advice

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Oversold Bounce Provides Relief

It was a good week for investors as global markets bounced to the tune of 3-4% overall. Of course, don’t look for an underlying reason for such a big move. It was simply a technical exercise that one can normally expect after a prolonged decline.

The S & P 500 Index, as I reminded readers last week, had been down 10% in nine days. That’s an unusual occurrence. Usually, markets will decline some, move higher for a bit, and then decline some more. That’s the pattern we are in right now. My guess is that there is a bit more upside in the averages but don’t be fooled. This correction is not over.

One clue to my cautious forecast is the continued anemic volume involved in these sudden upward spikes in prices. Another is the dearth of breaking news that might at least provide an economic reason for moving higher. Finally, I’m net neutral going into this second quarter earnings season whereas the past few quarters I was far more positive.

One reader from Sheffield wrote that, given my negative stance on the market, I must be expecting a double dip recession. That’s not true, but I do expect a slow recovery. My reason for calling an interim top in the markets back in April was that stock valuations were getting too far ahead of economic realities. I said then that we needed a pullback lasting several months to allow the economy to catch up to the stock market.

That is occurring this summer and as such we should expect the slowdown in economic activity from the first quarter to be reflected in company earning’s results starting next week. That’s not to say all companies will disappoint but enough will and managements will explain away disappointing results by blaming the economy.

Most double dippers point to one leading economic indicator, the Economic Cycle Research Institute’s weekly Leading Index, as proof that we are dipping backward into recession. This measure of future economic growth fell again for the week of July 2 to its lowest level in a year. However, one indicator does not a recession make. I believe that the ECRI’s index is simply tracking the decline of the government’s economic stimulus packages that have pumped mega billions into the economy.

But just because the economy is no longer on steroids does not mean it automatically falls back into recession. During the last few years I believe market players have developed an attitude of all-or-none when it comes to economic matters.

Take, for example, the sovereign debt problems of Greece and some other southern members of the EU. The market,s immediate conclusion is that Europe is done and will likely lead the U.S. back into another recession. China, on the other hand, begins to tighten interest rates to prevent overheating their economy and their stock market’s drop 30% with dire predictions of a massive economic slowdown. These are simply two recent examples of the hysteria that is driving the increased volatility in world stock markets.

If memory serves, there has been only one instance of a double dip recession in the U.S. over the last 100 years in 1980-81 (some argue it was two distinct recessions and not a double dip at all) and no one predicted it, nor did it occur when interest rates were at historical lows. Right now companies can borrow at practically no cost and invest that money at significantly higher rates of return. That fact alone will go a long way in fending off any tendency for the economy to back flip.

So why does the dreaded double D topic continue to pop up wherever you look? Excuse my cynicism, but it comes down to two words—November Elections. Nothing would help Republicans get elected more right now than a double dip recession.

Posted in A Few Dollars More, At the Market