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Strong Upward Momentum in Third Quarter
U.S. stocks continued the upward momentum that began last March, with quarterly gains in some indices that were the best in several years. The Dow Jones Industrial Index jumped about 15% in the past three months, the best quarter since 1998. Other stock indices had similar large gains.
Many global stock markets surpassed the gains of U.S. stocks. European stocks averages increased more than 18%, and broad emerging market stock indices popped up more than 20%.
Many analysts attribute recent huge stock gains to anticipation of a full-blown economic recovery, boosted by low interest rates, various government stimulus programs and ample liquidity in the system. Many skeptics have been confounded by the recent large stock market gains in the face of many economic unknowns. They predict another leg down in stock prices, if a wave of bad economic news is released in coming weeks.
US Economic News Remains Mixed
There are plenty of reasons for heated debate about the immediate direction of both the economy and stock prices. In late September, the Conference Board announced the Index of Leading Economic Indicators (LEI) rose 0.6% in August, the fifth straight monthly increase. July’s LEI was revised upward from the initial estimate of 0.6%. Five of 10 indicators improved in August, but three numbers were negative (real money supply, jobless claims, and capital-goods orders); two indicators were unchanged. It now seems that April may have been a significant economic turning point. Prior to April, LEI had declined for 20 straight months, reflecting the longest and deepest recession since 1981-82. Since April, however, the LEI has risen 4.4%. Eight of the 10 LEI indicators have improved over the past six months. In addition, three of the four coincident indicators – all but unemployment numbers – also improved in August. This is important because in six out of the past seven recessions, the coincident index has bottomed the same month as the U.S. economy – which could mean the recession now may be over. More positive data: The most recent Reuters/University of Michigan consumer sentiment survey rose to 73.5 in September, up from 65.7 in August -- the highest reading in 20 months. Since about 70% of the U.S. economy is based on consumer activity, consumer sentiment is monitored as a possible indicator for future economic trends.
Housing markets are an important factor to consider, however, in combination with other economic indicators. U.S. housing news is not good, and may become worse. The National Association of Realtors recently announced that existing home sales declined 2.7% in August after rising for four straight months. This shocked Wall Street, since existing home sales in July rose at the fastest pace in 10 years. For the first eight months of 2009, new home sales were down 28% compared to a year ago.
Given the bad housing news and mixed economic recovery statistics, it is not surprising that the Federal Open Market Committee (FOMC) said in their September meeting that “economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period”. Analysts have interpreted this to mean that rates will stay in a range of 0% to 0.25% for now. The FOMC did acknowledge that the economy and markets have improved since the August FOMC meeting, but appear to think that a sustained recovery is far from assured, that core inflation may still decline, and that the repair of the financial markets is still in the early stages.
Implication for Investors
In a late-December survey of top equity strategists by Barron’s, the consensus 2008 outlook for financial markets was optimistic. Against the dismal 2007 backdrop of record oil prices, housing deflation, rising loan defaults, and tighter credit conditions, these strategists forecast the S&P 500 will rally to 1640 in 2008, about 13% higher than the current level. Lower interest rates and continued global growth fueling exports are key reasons. The range of forecasts was wide -- 3% to 18% --but the direction of the forecast is notable in that it is positive across the board. Despite inherent risks of stocks, we agree with the top financial experts that stock prices are likely to rise in 2008. |
