WEEKLY ECONOMIC ANALYSIS: March 13th, 2009

Provided by TEAM Financial Services

"Nothing in the affairs of men is worthy of great anxiety."
- Plato

Items for Discussion

Well that was quick. We dragged out the old “stretched rubber band” metaphor last week and it surely did snap back. Rather than spend time speculating on what caused the market to turn higher, we’d like to examine how TEAM is approaching the situation. The S&P 500 index rallied over 13% from its low last week, which brings it within close proximity of 20%+ figure we threw last week as being common for a snap back rally once a major market decline exhausts. 

The critical question at this point is whether or not the low set last week could be a major cyclical bear market low, or whether any move higher will prove fleeting before substantial new lows are hit later this year? It is simply too early for us to make a judgment at this point, but we’ll share some initial signs of why the rally over the past week is encouraging. A major positive we’ve witnessed is a divergence between investor anxieties versus the underlying level of selling pressure in the market. Despite client portfolio values being higher than they were at the November low and having enjoyed a successful 2008, we received far more client inquiries in March expressing concern and real angst. So even though values were higher, anxieties are higher and this anecdotal evidence confirms some empirical gauges we monitor. A similar divergence emerged in October 2002 versus March 2003, as selling intensity peaked in October 2002 but fear peaked in March 2003 just prior to the invasion of Iraq.

TEAM cannot identify any major catalyst to drive a sustainable cyclical market low, yet that is to be expected. It is common throughout market history for stock prices to begin moving explosively higher despite the news flow being bad/terrible and getting worse. For example, the ultimate market lows in 1932 and 1974 commenced with few people believing it could be the case (sounds familiar) amongst miserable economic news (also familiar). Stocks gained over 100% in each case within 6 months of the low despite horrible economic news – one of which being the Great Depression remaining in full swing. 

While we are by no means forecasting a move higher of that magnitude or even that a cyclical low has been hit, we do observe encouraging positives that were not present at any of the major market lows in March, October and November of 2008. These developments were positive enough for us to fully embrace our stated objective to remain flexible and added additional portfolio exposure to commodities. Should the initial signs for optimism fade, then we expect to be quick to get more defensive. However, if signs continue to build, then a significant cyclical bear market low could be formed. Ironically, we would view a near term test lower that rattles investors’ confidence, but retains buying interest, to be more bullish over the intermediate term. 

Market/Economic Climate 

So what fundamental support could possibly be behind a protracted stock market move higher? First, the Weekly Leading Index growth rate from ECRI, our preferred economic forecasting firm, has stabilized and hit a six week high this week. This indicates the pace of the economic contraction is poised to slow over the next few months, which is an improvement. This firmly suggests that dire forecasts of another Great Depression are likely premature or even incorrect. If investors’ psyche’s are factoring in depression level assumptions and things develop better than that, then risky asset prices can adjust higher. 

Second, commodity prices are showing encouraging signs of stabilizing and making significant higher lows. Even though the economy is suffering its worst contraction in many decades, most commodity prices are “only” back to where they were a couple or few years ago. For example, crude oil is at about $45 a barrel despite a deep global recession. One could expect commodity prices to experience an even more dramatic collapse lower if economic activity was poised plummet into another Great Depression.

In summary, after making modest changes to portfolios to manage risk, we quickly seized on budding signs of a potential reversal in risky assets by increasing client exposure to commodity prices this week. We expect the current rally to at least match those off the March, October and November 2008 lows, which all reached 25%+. It could emerge into a more durable cyclical bull market lasting 6+ months, but it is simply too early to make a judgment.

Humor for the Weekend

This graphic comes via the Big Picture Blog authored by Barry Ritholtz.

Weekly Economic Analysis newsletters are provided by TEAM Financial, and are written by TEAM's Chief Investment Officer, James L. Dailey. Visit TEAM's website if you want to receive weekly economic updates right in your inbox - Click here.