Caution in April (3/23/2013)
MARCH 23, 2012
We feel the stock market has gotten ahead of the economy and that a restoring correction can happen any time. The correction could take us back to 13,300 on the Dow Jones Industrial Average, 1400 on the S&P 500, and under 3000 for the Nasdaq. However, if the economy continues its growth through the end of the year we will be able support these recent high prices.
On March 5, the Dow Jones Industrial Average surpassed its previous all-time high from back in October of 2007. Since early in the month, the market has moved slightly higher, although momentum has been reduced. Following suit with the Dow, the S&P 500 officially hit its own historic peak on March 28, the last day of the first quarter for 2013. Altogether, it took 5.4 years to recover the 40% loss induced by the financial crisis known as the Great Recession.
With the market up roughly 10% year-to-date, we believe that the big move can be linked to several factors. First, the Federal Reserve has reiterated its ongoing commitment to aggressive monetary stimulus, despite increasing criticism for those who question its effectiveness and worry about its longer term impact on inflation. Second, the failure in Washington to avoid the dreaded sequester will actually restrain federal spending this year and seems to have fostered a modest degree of cooperation among political parties. Third, the problems in Europe have mostly remained out of the headlines. Lastly, the US economic recovery does appear to be picking up steam, as evidenced by positive indicators in key areas, such as housing and jobs. Says Stuart Miller, CEO of the major homebuilder, Lennar Corp., “We are clearly in the midst of a recovery in housing and it is a fundamentally strong recovery. Prices are moving up not because costs are moving up so much, but because demand is getting so strong." He added that he wouldn't be surprised to see housing starts reach upward of two million when the recovery picks up steam, which is more than twice the recent annual pace. Regarding jobs, US nonfarm payrolls for February came in at 236,000 versus consensus of 160,000, the unemployment rate fell to 7.7% from 7.9% in January, and the four-week moving average of initial jobless claims has dipped to its lowest level since 2008, all of which are positive signs.
It is clear that the economy has come a long way from its lows of just a few years ago and is still showing signs of improvement, but it remains that optimism in the stock market can run way ahead of where the economy is. Furthermore, we recognize that there is a big difference between the stock market and the balance sheets of most Americans. For example, median household income, which is one of the broadest gauges of how households are doing in terms of income, is still down about eight percent from its 2007 peak. Consequently, Americans have good reason to feel that they're still sort of trying to catch their breath after the blow that they suffered during the financial crisis.
At this point, we feel the risk is higher on the downside than the reward of higher prices. Our view is that no one ever went broke taking gains. With technical indicators flashing overbought conditions, we have been taking profits and protecting gains with call options. We have been preparing our portfolios for a correction in the market which could start in early April. We are looking at a 5% to 8% correction to bring the market back in line with the economy and its true value. The correction should affect the same stocks and securities that ran up during the first quarter of last year, and were affected in the second quarter correction that saw a 1000 point swing in April and May. We will buy back into the market after the stock values are back in line. We feel the economy will continue to grow and support higher prices by year end.
Lastly, we wish everyone a wonderful Spring!