For a while there, it felt like Richard Dreyfus in Jaws might be right “I think we’re gonna need a bigger boat!“. With all of the crises we have been through lately, it feels like Shark Week. Danger lurking around every corner with big sharp teeth. Luckily,the fish have scattered. They’re still out there, but their bite is no longer imminent. Neither the turmoil in the Middle East, nor the impending doom of a nuclear meltdown in Japan, will jar the earth off its axis and hurl us towards the sun… at least not today.These events proved to be a catalyst for the correction we so desperately needed. The market dropped about 6 ½% from its high, right in line with the 5-7% I was looking for, and well under 10% which would have signaled a potential catastrophe. Sure, a retest of last week’s low is likely, but that level should hold. Now investors can focus on the fundamentals that truly drive stocks, the economy and earnings. With both of these, nothing has changed. The economy is “slogging through the mud” and slowly improving. It better after $14 trillion in stimulus!
It’s going to be a long slow road given that consumer demand drives an economy and our demographics of the aging baby boomer insist that demand will continue to be lackluster for the next few years. The main driver here is The Fed’s stimulus programs, or QEII. The market is addicted to this and if Bernanke tries to end it, watch out. I do expect the boys to let it end to see if the economy can stand on its own, but they will likely be forced to bring us another round of easing within a few months, just like last year after QE1 ended, whether through a QE3 or by another name.
Earnings will continue to be the main driver of stocks and they look like they will continue to be strong. It’s hard for individual investors to understand that the market can rise with all that’s going on around us, but they can and they will. I discuss this in depth in my 9/7/2010 commentary, Can Stocks Rise in a Horrible Economy?… You Bet! And when they do, the rally could be explosive, as many individual investors have been sitting on the sidelines in cash or bond funds, not because they are good investments, but because many have been too afraid to dip back into the stock market.
That will be called the catch-up rally, as people panic to get invested before they miss out. Luckily we’ve been in the right places for our clients the last few years and won’t need to play along. It’s good as it pushes the market higher. However, it can be deadly as it may signal the end of the cycle when the institutions, who have been on this rally since the beginning, sell at the top to the unsuspecting individual investor, just like they did the reverse when they bought at the bottom during the panic.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.