Stage Two of Recovery Beginning Now

Includes: DIA, GLD, QQQ, SPY, UUP
by: Jason Schwarz

Investing is a lot like surfing. You’ve got to paddle out, find your wave, adjust to it, and ride it in. The big wave that we've been riding since the March lows ended on January 14th when Intel (NASDAQ:INTC) reported an 875 percent increase in net income but somehow the stock managed to sell off. At that moment the propulsion of water underneath our surfboards turned into the friction of sand.

At, I called Q1 2010 a time when investors would be transitioning from stage one of the stock market recovery to stage two and that is exactly what has happened. Right now, investors are paddling out on our boards trying to get in position for the next wave. It’s not an easy process. You can get knocked off your board. You can have false starts.

In market speak, you can have a correction. Because we’re off the wave in the short term, the news of the day doesn’t have too much effect on price action. Apple (NASDAQ:AAPL) can blow the doors off earnings but nobody is actively surfing yet so it doesn’t matter. Obama can turn from an employment killer into an employment enabler but none of it matters...yet.

All of the good news we’ve gotten from the GDP report, the manufacturing report, corporate revenue growth, retail data, consumer confidence and on and on will soon matter. Until investors are comfortable getting back up on the growth wave we will be tossed to and fro at sea. It's these kind of conditions that cause us to actually trade for a few days based on Greek debt concerns. That’ll make for some great laughs around the bonfire a few months from now. We'll trade on the advice of PIMCO telling us to get out of equities and into bonds. The market finds any piece of news to justify a correction.

The truth is that 5-10 percent corrections happen in every bull market. They happen because the wave comes to an end as all waves do. As this correction comes to an end, the decisions you make during Q1 2010 are just as important as the decisions you made back in Q1 2009. The market is in the process of finding new characteristics to define the next stage of cyclical recovery.

So far, one characteristic is standing out above the rest. The U.S. dollar is replacing gold as the safe haven. Does America deserve this adoration? I think it does. It was only five years ago that we were all worried about the future of America. Our education system was supposedly inferior. Our math skills were in decline. We didn’t produce anything. Look at us today. We are the only ones on planet Earth who are innovating anything. American companies are in complete control of the biggest growth story of this generation - the mobile internet. Asia and Europe are following our lead.

Nobody can be certain what stage two of the stock market recovery will look like, but I’m leaning towards an environment defined by a rising dollar along with rising U.S. equities. For ten years our currency has been in decline and that hasn’t helped stocks at all. Those who tell you that the stock market only does well when the dollar is in decline have been lost at sea for the last ten years. A really high dollar is a bad thing, but we aren’t even close to being high. We have ten years of losses to make up for. A rising dollar off the lows is a very good thing. It should stimulate foreign investment in U.S. equities which will cause a multiple expansion cycle we haven’t seen for over a decade.

As we exit this stellar earnings season we have seen the p/e ratios of S&P 500 companies drop from the mid 20s down to 17. Attractive valuations along with a rising dollar could be the next wave to ride. Stage one of the market recovery brought us from Dow 6600 up to Dow 10,000. Stage two will be Dow 10,000 up to Dow 13,000 - still 1,000 points off the high from 2007. Stage one lasted nine months. Stage two will probably take closer to eighteen months. Its trends and characteristics will be established by the end of Q1 so continue to be flexible with your portfolio positioning.

Disclosure: Author holds long positions in UUP and AAPL