Earnings have recovered some, which isn’t surprising given the unprecedented 90% plunge in earnings as 2008 drew to a close. But earnings are still down significantly from the 2007 peak. Strategists who expect a “V-shaped” rapid recovery to prior peak levels are betting on a normal recovery, in the face of economic pressures from tight money and continued de-leveraging.
Last week’s stronger than expected job growth was more a function of fewer layoffs than more hiring, and few commentators mentioned that it was accompanied by a swelling number of people looking for jobs, so the unemployment rate was little changed.
The fundamentals still seem to be following my “stabilization amidst recession” playbook, but you’d never know it from media reports and market action.
It wouldn’t be the first time that the media misinterpreted market strength to mean that the fundamentals were improving, yet their analysis missed by a mile. In September 2007, as the subprime debacle began to unfold, the Federal Reserve started cutting rates while CEO’s lied about their exposure to the growing menace of defaults and mark-to-market pricing. A knee-jerk rally to new stock market highs, in October of 2007, didn’t change the fact that a financial crisis lay just around the corner.
Today’s efforts to climb back above 11,000 on the Dow are no more reassuring. Though we continue to position the portfolio for strength (don’t fight the tape), we have not lost our skepticism about the durability of this recovery. If the market keeps climbing the proverbial “wall of worry,” we don’t want to get left behind. But we are increasingly focused on trying to find contra-cyclical investment alternatives that could zig if markets flag and screens turn red once more.
However, we think that the stock market recovery reflects only a dramatic recovery in the corporate bond market – not in the economy overall, nor that prospects for investors are significantly better than they were nine months ago. Rock bottom interest rates have propped up valuations (boosted Price/Earnings ratios). End of story. Don’t draw too many conclusions from 2010’s market enthusiasm.
The rally has been led by low quality companies and sectors leveraged to the backs-against-the-wall consumer. In many cases, the sectors that have done best (banks, consumer cyclicals) are sectors with the worst economic fundamentals. We’ve seen the mother of all dead-cat bounces, but I’m still hoping to see some sign that the renewed “animal spirits” investors have shown will jump-start the economic engine.
All we know for certain is that prices are much less attractive than they were a year ago.
Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.
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