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Comfort Zone Investing: Can the market keep the rally going?

Posted Aug 28th 2009 10:30AM by Ted AllrichTed Allrich RSS Feed
Filed under: Comfort Zone Investing

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We've seen the market move up in a rather dramatic way since March, which is somewhat logic defying because most of the news has been bad over that time.

Certainly earnings weren't anything to shout about, but many of the forecasts sounded optimistic. Unemployment keeps growing. That's never good for the market. Housing lately is starting to find footing, stopping the continuous slide of lower prices, but over the last 18 months it's been in a depression. So with all the bad news, can the market keep its momentum?

Most likely it will. That's because the market looks ahead by at least six to nine months, and ignores the here and now. With the latest economic data and the re-appointment of Benjamin Bernanke as the Fed chief, investors have reason to believe there are numbers, not just hope, behind the latest market moves.

Housing is up. Home prices increased in 20 major cities by 1.4% in June, the second improvement in a row after falling every month for three years. (Source: Case-Shiller) Prices rose in 18 of the 20 cities with only Detroit and Las Vegas showing still lower prices. In May, prices were up .5%. After seasonal adjustments, prices rose .8% in June and were flat in May. While home prices are down 15.4% in the past year, that's an improvement over the record 19% year-over-year drop reported in January. For all of the second quarter (March through June), the national Case-Shiller index was higher by 2.9%, the first quarterly increase in three years.

So housing prices have definitely improved for most of the county. That's significant because the housing industry is one of the main employers, plus it has a ripple effect throughout the economy as complementary industries (lumber, furniture, landscaping, etc.) all feed from the housing plate. The only damper on this good news is that foreclosures could hurt prices again. If more jobs are lost, certainly more foreclosures will follow. More foreclosures will add to inventory and at distressed prices. Even now, many homes that are owned by banks or other lenders are being rented or held off the market in the hopes of seeing prices increase. There are plenty of houses still available at great prices. No one sees housing moving ahead in a meaningful way until supply and demand get more into balance. Still, the market likes the fact that, at least for the moment, housing prices are going in the right direction.

Consumers feel better. In the latest Reuters/University of Michigan report on Consumer Confidence for the month of July, its index rose to 54.1%, up from 47.4%, a much larger gain that analysts expected. They predicted a rise of .5%. That's the most optimistic consumers have felt since the recession began.Consumer confidence "appears to be back on the mend," said Lynn Franco, head of the consumer research center at the Conference Board, which is a private research group. Consumers were a bit more upbeat about current economic conditions but were markedly sunnier about the economy and their own financial situation over the next six months.

How does this affect the market? Consumer Confidence surveys are one of the leading indicators for economic activity. The assumption is that if consumers are confident, they will be more likely to spend on all types of goods and services, but particularly durable goods and long-term purchases such as houses and cars, two sectors that badly need help. The stock market likes this optimism, even if it is still relatively low. The direction is certainly positive, and the large increase in the number helps as well.

Interest rates are low. And should stay that way for a while. With all the inflation concerns because of the large government fundings, interest rates won't be allowed to go very high very fast. Chairman Bernanke announced that at the Jackson Hole annual economic conference. Interest rates tell you the price of money. When they're low, companies and people borrow more. That helps fuel economic recovery. Too much borrowing is what got us into the current mess, but that isn't likely to happen in this next cycle as banks are not going to make the same mistake so quickly. (They most likely will sometime in the distant future but not right now, especially with the Fed monitoring almost everything but their heartbeats.)

With interest rates low, companies can borrow at attractive rates to expand their businesses. Consumers can finance home purchases more easily (and more will qualify to buy homes because the payments will be lower). As long as rates stay low, economic activity has a chance of picking up sooner rather than later. Again, the Fed will be monitoring this activity closely, and any signs of inflation coming too quickly will cause tightening. But given current activity and the banks' reluctance to lend, no such concern is warranted now. The stock market likes low interest rates as long as there is also economic activity. Low rates will help bolster the stock market as investors anticipate higher sales and profits, with margins widening because of lower interest payments.

So there are good reasons to think the market will continue on its upward path. Some will argue that all of this is already baked into the current prices as the market has moved strongly in a relatively short time. But just as the investors over-reacted to all the bad news and sent the market crashing to very low valuations, they will also be quick to jump on any good news and send stocks higher. That's the way the market works. It overshoots in both directions, eventually settling on a level that fairly reflects the values of stocks.

For now, with the summer over and many investors returning after Labor Day, expect to see renewed optimism, bolstered by better housing numbers, more confident consumers and low interest rates. And if unemployment numbers can stop going higher, this market will really take off.

Ted Allrich is the founder of The Online Investor, founder of Allrich Investment Management, LLC, as well as the author of the book Comfort Zone Investing: Build Wealth and Sleep Well at Night. In this weekly column, he'll offer advice to investors who are just getting started.

Tags: Ben Bernanke, Comfort Zone Investing, economic recovery, featured, interest rates, stock market, Ted Allrich

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Last updated: November 23, 2009: 08:44 AM

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