I think it’s probable that the stock market will continue to convulse for the rest of the third quarter and into the fourth. The trend in economic news is down and so is investor sentiment. We still have a lot of problems with sovereign debt issues in Europe and this is an investment risk that isn’t going away anytime soon.
Right now, investor expectations are being dramatically reduced. The marketplace now expects little to no growth in gross domestic product (GDP) and investors aren’t expecting much, if anything, from the stock market. I still expect both the third and fourth quarters to be very good in terms of corporate earnings, so my view is that the stock market will undertake a prolonged period of consolidation around current levels, with chances of rallying in the fourth quarter.
The old adage that investors should “sell in May and go away” perfectly illustrates a fitting strategy this year. If you pull up a chart on the S&P 500 Index, you’ll see the market’s substantial price appreciation from last September. Then in May, the market began to consolidate; slowly deteriorating until its recent move, breaking both its 50-day and 200-day moving averages.
The S&P 500 Index has actually been in a period of consolidation for the last 11 years. Pull up a long-term chart on the Index and you can see it plainly. What you will also notice is the current price action, which looks like a right shoulder formation from the head set in 2007. It’s an ominous-looking pattern and, when looking at it, you can’t escape the feeling that the trend is going to complete itself. If it does, it means the stock market could be in for a lot more pain. Over the last decade, 800 on the S&P 500 stands out as the bottom support point. Regardless, the buy-and-hold investment strategy has barely paid off over the last decade. Without dividends, investment returns would now be negative, as the S&P 500 is currently trading below its level in December of 2008.
Clearly, the best stock market advice would have been to buy technology stocks and Internet stocks in the 1990s. Then, the best subsequent investment strategy would have been to cash out of the stock market and buy real estate for most of the next decade. Now, it would seem, precious metals and agricultural commodities are experiencing the best price action from the global business cycle. First it was stocks, then it was real estate. Now the future belongs to commodities.
I think the commodity price cycle will keep running for a number of years and, in a period of slow economic growth, investors need to have significant exposure to this sector. The fundamentals haven’t favored stocks for quite a long time. The real estate cycle was strong and highly profitable for those who got in and out at the right times. Now, all the debt in the world and money supply growth is creating a sustained period of higher inflation. Going forward, commodities and those assets that benefit from higher inflation will be the winners.