What’s Really Happening with the Stock Market

— by Michael Lombardi, CFP

It was a good day for earnings reports on Wall Street on Friday, as American Express, Wells Fargo, Marriott and even Ford Motor Co. all beat the Street profit expectations. For the month of April, the “rash” of good earnings and economic news sent the S&P 500 rallying to its best monthly performance in nine years.

People are feeling better about the economy. My real estate agent told me Saturday that “the stock market is moving higher; the real estate market will follow.” The U.S. Federal Reserve said Wednesday that it sees signs that the recession is easing and the economy has improved modestly. And the Reuters/University of Michigan Consumer Index for March jumped the most it has in two years.

Hogwash, that’s what I say.

The stock market isn’t moving higher because of good economic news or because of better-than-expected earnings reports from companies. The stock market is rising because it is simply rebounding from a severely oversold condition reached on March 9, 2009.

Look at these facts. In 2008, the great Dow Jones Industrial Average lost 35% of its value, one of the biggest yearly percentage drops in its history. And, up until March 9, 2009, the Dow Jones had lost another 27%! Nothing goes up in a straight line and nothing falls in a straight line. Stocks became so oversold in March 2009 that fund managers came in and started buying stocks. The short sellers (those betting that the stock market was moving lower) then needed to cover their positions, sending stocks even higher.

Friday, we will hear another devastating jobless report: 500,000 jobs lost in April, or 600,000 jobs lost? Whatever; the number of job losses is staggering. The official unemployment rate in the U.S. is 8.5% as of March (I believe that number is headed for at least 10%). If you take into consideration part-time and “discouraged” workers, the unemployment rate is really 15%. An entire consumer segment of the economy that was spending money is now disappearing.

Finally, the devastation of the auto industry in North America (do we really have an auto industry anymore?) will have lingering effects for years. Think of not just the car makers, but think of the factory job losses, the dealerships that will close, the parts makers that will go bankrupt.

Dear reader, the stock market is far from being out of the woods. I can only hope that when the market lows of March 9, 2009, are re- tested in the months ahead, the stock market will not fall significantly below those lows.

Michael’s Personal Notes:

The downturn in the commercial real estate market has only just begun. Prices paid for office towers in New York at what I call “stupid” prices are now being undone, as lenders foreclose. Yields on investment realty fell to ridiculous depths, while interest rates collapsed and easy money was available. Now that the credit bubble has burst, mortgage money is tight and tenants are having difficult times paying their rent, prices on commercial real estate will fall. In the same way residential housing prices fell two years in advance of commercial real estate; residential housing prices will lead the eventual recovery, with commercial real estate lagging. For real estate investors, deals on investment properties will only get better.

Where the Market Stands:

The gap continues to narrow. The Dow Jones Industrial Average is now down only 6.4% for the year. Readers have known my prediction for months: The Dow Jones will recover all of its 2009 losses and even turn positive for the year, as the bear works its magic, bringing investors back into the stock market. Once investors are back in the market, I believe that the lows of March 9, 2009, will be tested again. Why do I see this? Two reasons. First, fund managers will not sit back and watch the market rise without them being part of it. Hence, the fund managers are entering the market.  (Fund managers live in a fear of not beating the market averages.) Second, bear markets end with stocks becoming great values. The Dow Jones Industrial Average never became a “great value” when it
hit its low on March 9, 2009. And stocks are hardly a deal today with the Dow Jones trading at 32 times earnings.

What He Said:

“Over the past few weeks, I’ve written about subprime lenders and how their demise will hurt the U.S. housing market, the economy and the stock market. There’s no escaping the carnage headed our way, because the housing market and subprime business are falling apart. The worst of our problems, because of the easy money made available to borrowers, which fueled the housing boom that peaked in 2005, have yet to arrive.” Michael Lombardi in PROFIT CONFIDENTIAL, March 22, 2007. At the same time Michael wrote this, former Fed Chief Alan Greenspan was quoted as saying “the worse is over for the U.S. housing market and there will be no economic spillover effects from the poor housing market.”