Sentiment remains very negative, as demonstrated by the outpouring of comments in response to any piece of weak news. Strong reports get short shrift. The rally in stock prices is dismissed as either unsustainable or inconsistent with weak fundamentals, or well beyond what the weak economy can support. Forecasts project weakness until there is evidence of strength, which is promptly dismissed as unsustainable. This widespread pessimism seems to reflect the high level of unemployment, but overlooks the turn in the data. The outlook should brighten in time.
Commentary on the latest housing data provides a great example of the widespread pessimism that abounds. The sharp decline in October housing starts was taken as strong evidence that the recovery visible in the earlier data was an illusion, a conclusion reinforced by a modest rise in housing prices reported by the Case-Shiller survey. Analysts ignored that any rise in housing prices in October was counter-seasonal and was the fifth consecutive monthly rise after more than two years of years of consistent declines. Existing home sales rose sharply, rising almost 25% over last year, while inventories plunged to 7.0 month’s supply versus 11 months less than a year ago. And even with the drop in new home sales, inventories are down to 30 year lows with a population more than 50% higher. Even pending home sales data remain strong. Prospects remain very bright for an ongoing recovery in housing, one weak housing start report notwithstanding.
Everyone seems to be anticipating a setback in stock prices after the surge since March. Although forecasts for a large correction or a “retest” of the March lows are common, they violate recovery norms. Stock prices always leap ahead of economic recovery, as investors anticipate the economic rebound. This rally won’t be reversed unless the expected recovery fails to materialize, an unlikely event, in our judgment. If the economic recovery proceeds as expected, the stock market rally will continue to advance, although at a more moderate pace that reflects the actual rebound in corporate profits. So far, corporate profits have performed far better than normal, reflecting the extraordinary cost cutting implemented by business during the economic collapse. This sets the stage for a strong rebound in corporate profits, as the expansion resumes and will provide a solid foundation for the appreciation in stock prices. Significantly, the rise in stock prices has occurred despite extremely weak flows of retail cash into mutual stock funds. Investors remain nervous, as well demonstrated by the vastly greater flow of retail money into bond funds. The retail investors get it wrong and analysts just feed into this recurring mistake.
Disclosure: No Positions