Slow and steady keeps the Fed at bay and inflation contained
The U.S. business expansion continues on a slowly improving course. The headwinds of debt contraction and illiquidity strains have significantly diminished. Consumers are adjusting to slimmer paychecks since the beginning of the year due to the end of the year payroll tax holiday. U.S. business (now very productive) is positioned to better compete in the world economy. Costs have been pushed down. The danger of a recession has significantly receded. The economy is healing from the turmoil of the Great Recession. The leading economic indicator suggests a moderate, still sluggish expansion. The good news: this subpar slow upward path can lengthen and sustain this developing cycle because this climate doesn't ignite inflation.
There is tremendous excess capacity in the U.S. economy. Real Gross Domestic Product is significantly below the real potential GDP growth path. This very wide gap concludes inflationary pressures will not develop. The European economy continues to contract. Italy and Spain are struggling. Germany and France are faring better. Europe's turnaround may contain our economic growth. Most important: the financial markets throughout Europe have improved.
A review of the housing and financial bust
The housing and financial stocks have exhibited a boom, bubble and bust cycle. A solid growth expansion is now likely for both of these industries. A turnaround for both financial and housing stocks suggests a brighter stock market and economic outlook. A decade ago we owned the housing stocks. They turned into solid performers and clients achieved healthy gains. The stocks soared as the housing mania grabbed hold. Eventually wild speculation and easy financing brought about a mania --- an excitement and contagion that the good times would last forever. We spotted trouble in 2006. Many housing stocks such as Toll Brothers (TOL) and DR Horton (DHI) traced out a parabolic curve which outlined the mania. Soaring stock prices against these parabolic curves spotlighted the near vertical "launch to the moon" pattern. Skyrocketing home prices and euphoric predictions were just not sustainable. A break below the parabolic curve was the first confirmed sign of trouble in 2006 for the housing stocks. Ditto for the financial stocks, especially against the background that the Federal Reserve was pushing interest rates higher. We sold and considerably lighted up on our stock portfolio. The mania was about to implode. The bust and Great Recession soon followed. Over the next 6 years Toll Brothers sank 70%. D R Horton got smashed. So did the financial stocks. Financial and housing stocks often rise and fall together. Easy financing fueled the housing boom. A cutoff in financing choked the entire real estate industry. Prices then plunged. Financial stocks tumbled over the cliff. The banking industry faced insolvency. The miserably managed Bank of America (BAC) purchased Countrywide Financial and Merrill Lynch just before the onslaught. Both Citigroup (C) and Bank of America nosedived. Okay, we just briefly outlined the boom, bubble and bust for the housing and bank stocks, plus the stock market and economy.
Financial stocks pivoting into an uptrend points to a bull market
For the financial industry, we believe most of the horrible news has already surfaced. Bad investments have been wiped off the books. Layoffs have ensued. Balance sheets have improved. A new business model and new management is in place. Next step: a turnaround for the financial stocks (and housing stocks). Our low risk investing methodology focuses upon stocks and industries pivoting from sharp, well defined downtrends into potential major up-trends. Most often these up-trends last many years. Both the housing and financial stocks fit this script. Clearly the housing and financial stocks illustrate this ideal turnaround pattern. Housing stocks, like Toll Brothers and D R Horton, pivoted a few months ago. We recently purchased Bank of America and Citigroup because of these powerful breakout patterns.
The major trend for the banking industry parallels the health of our economy. Economic expansion depends upon increased investments, expenditures and spending. Your spending is someone else's income. Your debt is someone else's assets. Financing and leverage is the core of business expansion. A failing banking sector led to the Great Recession. A deteriorating banking system jeopardized our entire economy. The major waterfall decline for bank stocks post 2007 led to and paralleled the Great Recession and the vulnerable and anemic business recovery that followed. That's why the Federal Reserve pushed down and held interest rates near 0% and printed trillions of dollars. The recent upside breakout for most of the financial stocks including Bank of America and Citigroup now suggests the backslide into a recession is minimal. Banks are now eager to lend and encouraging customers to borrow. Increased borrowing and lending will power this business expansion. The major pivot and developing uptrend for the financial stocks will mirror an improving economy and rising stock market.
A financial stock break out in late 1990 led to the a booming stock market during the 1990s (and the financial stocks led the way). More good news: Many international bank stocks such as Barclays (BCS) and Royal Bank of Scotland (RBS) have exhibited upside breakouts from their major, steep, multi-year downtrends. Very healthy and very positive.
In summary, many signs point to an improving, healthy and sustained uptrend for both the economy and stock market. The financials will help strengthen and lengthen this expansion.