Anticipation (the song, the market)

Copyright © 2009, Greenwich Financial Management Inc., a registered investment advisor.
In the song “Anticipation,” Carly Simon sings “We can never know about the days to come/but we think about them anyway, yay.” As with Ms. Simon’s lyrics, U.S. stock investors have likewise been “chasing some finer day.” At a level of 888 on the S&P 500 Index (closing price, 5/21), we are now about 33% above the lows of 667 from March 9th of this year. We had gotten as high as 929 on May 8th (up 39%), before the market experienced some retreat.

Economists consider the stock market a leading indicator (predictor) of economic trends. However, Nobel Prize winner Paul Samuelson has written: “To prove that Wall Street is an early omen of movements still to come in GNP, commentators quote economic studies alleging that market downturns predicted four out of the last five recessions. That is an understatement. Wall Street indexes predicted nine out of the last five recessions! And its mistakes were beauties.” (Newsweek column, 19 September 1966)

Even so, the stock market probably has a better prediction record in this regard than, say, the average opinion of top economists, called the “blue chip consensus.” Investors and traders have been focusing on these positive factors, among others:

• The shrinking “TED spread,” which reflects confidence in banking institutions by other banks.


• The beginning of recovery in certain hard hit residential housing markets.


• The rally in investment grade and high yield bonds, reflecting greater confidence in the ability of issuers to pay on their obligations.


• The decisiveness of the Fed, the Treasury Department and the White House in moving to stimulate the economy.

The reversal of shrinkage in the supply of money, as measured by M1.

Investors, however, may not be giving enough weight to these negative factors:

• The uncertain course of many economies on which we rely for international trade.


• The continued sluggishness of bank lending.


• The likelihood of further increases in the rate of unemployment.


• The likelihood of a continued decline in some other residential housing markets, and in commercial real estate, which were less hard hit initially.


• The danger of inflation or even stagflation (stagnation plus inflation) emerging as a negative investment theme in the near future.


• Our national debt and budget deficit dilemma.


• Weakness in consumer demand.


• The possibility of a bottomless pit in efforts to bail out domestic carmakers.


• The rather high price to earnings ratio of the stock market as a whole, as measured for example by a ratio of about twenty times 2009 expected earnings for the S&P 500 Index. (See "No Pig Heaven," by Alan Abelson, Barons, 5/18/2009).

My view is that we are indeed in the process of climbing out of a bear market. This has not been a false rally in that sense. Volatility (fluctuation of prices) has fallen from late last year (having reached an astronomical 80 on the VIX index then and about 32 now). I see the recent forceful rally already losing some steam, and I anticipate we will spend several months fluctuating within a band of about 30% to 40%above the recent lows.

Andrew Szabo CFA is managing director of Greenwich Financial Management Inc., a registered investment advisor. Questions call 917-796-8500 or e-mail Szabo@GreenwichFinancial.com). For more information, please visit http://greenwichfinancial.com/.