I have a strong sense that the stock market trading action we’ve experienced over the last several months will continue over the next quarter or so. One day, the stock market will be up on some positive economic news; the next day, the economic news will point the other way. The stock market is at its current level largely due to two equal factors—the Federal Reserve and reasonable valuations. At the beginning of the year, the U.S. central bank said just what institutional investors wanted to hear—it will support the economy further if necessary. This lit the fire of equity market buyers and, because current corporate earnings support current valuations, the market has held up well.
The trading action since the March 2009 low set during the financial crisis has been remarkably repeating itself quite succinctly. When economic news showed improvement, the stock market accelerated briskly and after a while the trend experienced a meaningful correction. After several months of correction, another decent piece of economic news sparked another upward leg. Just pull up a four-year stock chart on the S&P 500 Index and you can see the consistency in the trading action.
Extending this consistency to the near future, it would seem that we’re on the final leg of a stock market that’s ready to top out and experience another correction. According to the chart, the length of the upward price trends since March 2009 is getting shorter and this leads me to believe that the stock market is setting itself up for a big top, not just another correction. This, of course, is a gut-feel type of analysis. Nobody can predict the future.
The inconsistency in the marketplace is the economic news itself, which continues to highlight uneven recovery in the U.S. economy. The inability of important economic news like orders for durable goods or consumer spending to show a consistent trend is in itself telling. Economic recovery in the U.S. economy is still very fragile and, as a stock market investor, it makes it very difficult to bet on. (See How Are You Going to Earn in the Age of Austerity?)
There remains an underlying strength to the stock market today. Investor sentiment isn’t robust, but it isn’t in the doldrums either. With first-quarter earnings season mostly over for large-cap companies, inconsistent economic news is going to produce inconsistent trading action in the equity market. The economic news isn’t all that bad; it’s just not showing any lasting robustness. It seems to me that the near-term trend is that there isn’t one.
We’re in a stock market now that is completely event-driven. Stocks are fairly valued and earnings expectations are modest. Betting on an underlying theme like low interest rates or recovery in the housing market seems irresponsible, because the Federal Reserve has pretty much done all it can. Prospects for the U.S. economy therefore lie entirely with the individual.