Insights & Advice

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Progress not Perfection

All in all it was a sloppy week on Wall Street. Bulls and bears pushed the averages back and forth fighting for that level called the “200 day moving average” (200 DMA) which happens to coincide with the 945 level on the S&P 500 Index. This battle has raged all month and neither side has won. What is clear is that for the rally to continue and become more than a bear market bounce that level must be breached and breached decisively.

The 200 DMA is a technical term used to describe the average price of a stock or in this case an index over a specified period of time (200 days). Analysts and most other professional investors use this average to help determine the overall health of a stock or index such as the Dow or S&P 500. An index that is trading below its 200DMA is in a downtrend like the markets we have experienced over the last year or so. A stock or index trading above the 200DMA is considered in a long-term uptrend. Normally in a healthy market, the 200DMA is rising. In order for this rally to “have legs” that formidable level of resistance must be crossed.

As predicted, General Motors dominated the headlines all week as it’s “on again, off again” Chapter 11 bankruptcy looms. Monday is the deadline and date that GM must submit a reorganization plan to the government or face bankruptcy. Anticipating the worse, the stock price fell below one dollar on Friday. Bets are it goes into a short and pre-packaged bankruptcy similar to the model Chrysler is using in its own bankruptcy filing rather than a protracted event. Either way it appears the market has had sufficient time to absorb the implications of the largest bankruptcy in U.S. history.

The bond market has also been the cause of volatility this week. As I warned in “Caution; Summer Ahead” in my last column, the government is the process of raising billions in new debt to pay for all the spending they have been doing. Bond investors are balking at buying anymore paper unless they get a better rate of interest.
As a result, long term interest rates are moving up and yields are starting to rise. By itself, that should not cause alarm among stock markets participants. Rising bond yields are determined by inflation expectations as well as the expected real rate of return on capital made to keep the economy growing. Higher inflation expectations are actually good for stocks since it means that investors expect the economy to begin growing again while higher returns on capital are why people invest in the economy in the first place.

It is a sure sign that investors are beginning to believe that the monetary and fiscal policies of the U.S. and other governments are in fact working. It indicates that last year’s fear of deflation, a crumbling financial system and world economy are no longer justified. Bottom line: higher yields are exactly what should happen when an economy is coming out of a recession.

The trick is in controlling the rate at which interest rates climb. Too much inflation will create havoc in the bond markets and the economy as a whole. An economy that goes from recession to growth too quickly will also spark concern and disrupt the recovery process. A nice gradual growth rate would be the ideal middle way which is what the Obama administration and the Federal Reserve are shooting for. The devil is in the details however, and that my dear reader is why the markets are trading back and forth right now.

“When will we know for sure?” asked a frustrated friend of the family who was still completely in cash.
He was visiting the Berkshires last weekend for the first time and is a highly conservative doctor who was burnt badly last year by the market decline. He was also impressed by our bucolic lifestyle and our region’s cultural attractions.

“We’re making progress, “I explained in my best bedside manner, “but nothing in the economy, in the recent statistics or in the market’s reaction to these events is going to be perfect. But in the meantime, if the S&P breaks 945, I suggest you start getting back into the market.”

Posted in A Few Dollars More, At the Market