If the market’s going up, why does everyone feel so down?Submitted by Affiance Financial on April 12th, 2012
By Seth Meisler CFA, CPA/PFS
The most recent low in the S&P 500 Index was Oct. 4, 2011 when it reached approximately 1,075. Since then, it has climbed as high as 1,406 on March 19, 2012 (when we went to press)—a gain of about 31%. By definition, a 31% increase in the S&P 500 over a six-month period should be viewed as a bull market. While not back to all-time market highs, we’ve now retraced our steps to levels not seen since May, 2008. Investors should be pleased—yet the sense I get from talking to both clients and colleagues is a general uneasiness.
The Good News
The economy does appear to be on the mend and is undeniably growing. Unemployment is decreasing (8.3% as of February 2012) and employers are hiring, adding 200,000 jobs a month for the last six months. Consumer purchases have increased—for cars as well as ipads. Commercial and industrial loans are up 13.5%. Manufacturing is also up 3.2% over the last six months, compared with 1.5% in the prior six months. The decision by Europe to create the LTRO (Long Term Refinancing Option) in December, 2011, has allowed European banks access to capital and thus prevented any immediate default. It should be noted that in addition to stocks, many asset classes that involve risk have improved.
The Bad News
Consumer income, after inflation, has remained flat over the past six months. The Gross Domestic Product (GDP), while increasing, is expected to grow at only 2% in 2012, low by historical standards. While Europe has successfully kicked the Greek can down the road, the issues associated with that economy are significant. A recession in Europe could reduce the US GDP by 1%. Rising gas prices could be exacerbated by a potential conflict with Iran. Increased concern about rising debt and taxes, as well as the general dysfunction in Washington, are also cause for worry. After all, it was last year’s budget impasse that ignited the 20% drop in the market, leading to its 2011 low. Finally, home prices continue to lag.
The Big Unknown
Because of the opacity of the data, China continues to be an unknown of major significance. It appears that China is headed towards a soft, rather than a hard, landing in terms of continued GDP growth, but due to the lack of concrete information, it is impossible to know for sure.
In reviewing the U.S. economy, we should not dismiss interest rates and the role of government. We have two actions in play—the Federal Reserve system (the Fed) and Congress. The Fed, which has done an admirable job of keeping this economy moving, has been artificially lowering rates. These low rates allow the Federal government to borrow more cheaply and helps reduce the government’s deficit. But just think what will happen to the U.S. deficit when interest rates—inevitably—rise.
Moreover, interest rates have been beneficial in the corporate sector. Reduced interest rates have given corporations access to cheaper debt. This, in turn, has allowed corporations to post better profit margins. The fact that stocks have been moving up is directly correlated to Federal Reserve engineering. Each Fed program (QE1, QE2, and Operation Twist) has caused the majority of stocks in the S&P 500 to rise above their 200 day moving average. The thinking behind this approach is to provide the economy with enough thrust so that it can take off and fly on its own.
Why the Fear?
Looking back, it’s amazing to consider what we’ve experienced over the past five years. From the “Great Recession” in 2007-2009 to continued unemployment, an overhaul in health care legislation, a tsunami and nuclear crisis in Japan, simultaneous wars in Afghanistan and Iraq, the euro crisis, and a looming threat in Iran—it’s no wonder investors feel exhausted.
This exhaustion may be reflected in the lack of volatility (since Oct 2011) in the market as compared to historical averages. Recent volatility is also low as compared with how volatility looks going forward, as calculated by Morningstar. It appears as though the wind is at our backs, and we should never fight positive momentum—or the Fed. But the current complacency may be due in part to relief that we have been making back the 18% the market lost between July and October 2011. We need to be careful not to become too complacent, as it appears the market and investors may be unprepared for next chapter in this ongoing saga. Therefore your advisors at Affiance Financial are moving proactively (some might argue, prematurely) to reduce risk.
The views are those of Seth Meisler and should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. All economic and performance information is historical and not indicative of future results. Investors cannot invest directly into indexes.