October 26th, 2009 2:19 PM by Mel Samick
Stocks are flirting around the Dow's 10,000 point level as investors await the Government's first reading on the economy in the third quarter, later in the week amidst a fresh round of earnings reports. The stock markets seem to be pricing in a "V-shaped" recovery and so far, the data has not been disappointing with earning season already in full swing. However, any data surprise on the downside can have the effect of triggering a significant correction. The U.S. recession is most likely over, but the debate continues as to whether the Government should to do even more to bolster the recovery. Economists polled by Reuters think Thursday's GDP data will show the U.S. not only resumed growing in the third quarter, but did so at a pace substantially above the pre-crisis trend rate of around 2.5 percent. Overseas markets also show rising growth as Asia's economy is well on its way to recovery. South Korea reported its economy grew at its fastest pace in seven years. Other emerging markets like China and India are on fast-track too.
A sense of calm has started to pervade markets, with many assets now moving in narrow ranges and others just trending gently. This may not be great for active managers, but is a boon for those seeking stable risk-return after all the stormy seas during the past two years. Market tranquility reduces the destructive urge to de-lever our finances all at the same time, and helps rebuild markets and asset values, while keeping short cash and long assets that pay income and growth.
The message from the economic data is that a global recovery is taking hold and is spreading. Few investors still doubt that it is sustainable, while others believe it may continue at least through next year. Stability is most painful for assets that thrive on fear, which means cash. Since March, we have seen a steady and global flow out of cash into assets with an appropriate yield -- equities and bonds. This is not over. An informal look at the global portfolio share of cash hints that with cash returns staying at around zero, we are probably only half-way into the move out of cash. Most investors follow the strategy of borrowing in dollars in this low rate environment and investing in assets across the world. This is commonly known in investment circles as the "carry trade."
Although a very weak currency hasn't yet sparked inflation, the declining dollar is seeing investment money pumping up commodity prices such as gold and other metals, etc. The recent jump in oil prices despite tepid world demand and bloated inventories may suggest that run-ups in some materials prices have no fundamental underpinning. The price of gold continues to shine and some gold bulls are already dreaming of gold prices reaching $1,500 an ounce. However, it is possible in only two scenarios, the first reason being world inflation, which is not likely to happen over the next 2 years, and the other is the risk of a near depression, which may have already been averted. Oil prices reached $82 last week, the highest in a year, in a rally many say was triggered by expectations of an economic recovery and a weak dollar rather than a tighter oil supply and demand balance. Thankfully, gasoline prices are still low and may help us to afford a cozy winter season ahead. Hopefully, the ongoing overheating of commodities prices spares our heating bills.
Additional fresh news about the nation's housing markets was fairly upbeat, if a little uneven. Existing Home Sales, powered by low mortgage rates and low home prices, and additionally triggered by a fast-approaching expiration of the $8,000 "first time" homebuyer tax credit, leapt by 9.4 percent in September. The 5.57 million (annualized) rate of sale was the highest in over two years, and prices firmed while inventories dropped to a closer-to-normal 7.8 months of supply. The supply figures don't count the entire inventory on the market as they may not fully account for short-sales and foreclosure dispositions. While the trend is encouraging, how long it will last is an open question.
The rates market is at a crossroad. This week brings large supply as the market hangs near recent support levels. The larger issue is ongoing concern for longer-term inflation. Barring a sharper decline in inflation data, the Fed will need to take measures to address these concerns for the market to make new yield lows. In the interim, the risk of a move to higher yields remains a valid worry. The Fed is in a difficult position because it rightly fears ongoing deflationary pressures even as bond market experts continue to worry about long-run inflation risk.
The week's economic calendar includes the GDP report on Thursday and the FOMC meeting on Wednesday, November 4th in which the market is discounting a zero percent chance of a rate hike at the meeting. But the market will be watching for any language changes in their statement release. This week, earning season is busy as 149 of the S&P 500 companies are due to report. Economic reports of interest include Wednesday's Durable Good Orders and New Home Sales report.
Information provided by Amtrust Bank Capital Markets