S&P 500 Breaks Above Resistance

The S&P 500 Index has continued to track sideways at just below well established resistance at 1135 level during the remainder of last week. On Monday the index opened higher and accelerated through resistance to close at 1142.71. This marked the highest level the index has reached in 4 months. Although the staying power of the recent breakout is yet to be established in the short term, it is significant.

Although volatility could return at any time, with quarter end next week and hopes for more Federal Reserve intervention via QE2, we would not be surprised to see the market make a run to 1175 or the "flash crash" high of several months ago.

With the majority of economic data now surprising to the upside, fears of a double dip have decreased dramatically and the unwinding of this negativity has had a powerful effect on the markets.

National Net Wealth

Below is a 20 year chart of the national net wealth in the USA. It is essentially Housing Equity + Stock market Value and is compliments of Fusion Analytics.

The value of US stock and housing equity fell 25.7% from the pre-crash peak (June 2007) to the recent low – $65.8 trillion down to $48.8 trillion — a destruction of value of nearly $17 trillion dollars. This is a very large amount of wealth destruction and will take time for it to return to peak levels. Perhaps this explains some of the negative sentiment on Main Street...

Continuing Claims Holding Steady

As we discussed back in June of 2009, possibly one of the best predictors future growth in the US economy is a moderation in continuing unemployment claims. Continuing unemployment claims are those who are receiving benefits on a weekly basis.

To obtain a better perspective on unemployment during past recessions, below is a chart of continuing claims (those who continue to receive weekly benefits) dating back to 1971. (Click on chart for larger image)





Looking at the chart, the line shows continuing claims as reported each week. You can see that the last several months have been clustered in the 4.5 million range after spiking to over 6 million in 2009. Let's take a look back at the last three recessions to gain a better understanding of past cycles.

The early 1980's recession officially lasted from January 1980 until November 1982. As you can see on the chart the peak in continuing claims came in November 1982. The continuing claims dropped significantly over the next two years as the economy experienced a robust recovery. Economic growth was spurred by the Fed lowering interest rates and Congress reducing tax rates.

The early 1990's recession officially lasted from July 1990 until March 1991. Reviewing the chart we can see that the peak in continuing claims occurred in the first quarter of 1991. Although the recession ended in the beginning of 1991, it wasn't until the second half of 1992 (when continuing claims dropped) that the economy began a recovery.

The early 2000's recession lasted from March 2001 until November 2001; again the recession ended as the continuing claims figured reached a peak. Unfortunately, the ensuing recovery was rather anemic and job creation was below past recovery levels. The economy didn't really gain meaningful traction until the end of first quarter of 2003, many months after the recession officially ended.

While we hope we begin to experience job creation and an improved employment picture, we believe it is possible the recovery may be very similar to the most recent recessions in the early 90's and 2000's; where continuing claims remain elevated or clustered for several quarters (in this case around the 4.5 million level) and economic growth experiences rather anemic trends until continuing claims begin to steadily decline. This statistic will be important to watch in the coming quarters.

Less Bearish, More Opportunistic

During August I spoke with a investment manager who happens to be a friend of mine. He told me he couldn't remember a time when he was so right about the overall macroeconomic data yet couldn't figure out the direction of stocks and bonds. We talked for some time and I told him that it is important to remember that you typically can't make sound investment decisions strictly based on economic data. In the real economy, things are bad and will likely get worse for the foreseeable future. However, stocks don't always move with the economy.

Stocks move up or down based on current earnings and (this is important) the future expectation of earnings growth. While the economy can be mired in a slow down for many months, the stock market can move higher, seemingly defying forecasters as the economic data points remain weak, while earnings continue to grow.

The time for being overly negative about the economy has likely passed. It's time to adjust to the new reality and prepare for the future environment.

The reality is that no one knows for sure when companies will begin hiring again or when the housing market will turn around or when consumers will begin spending again. However, we have endured a terrible domestic stock market over the past decade and everyone in the media, as well as economists and strategists continue to paint a bleak picture. It is at times like these, when everyone is very pessimistic, to begin thinking from a contrarian perspective - emphasis on "thinking."

Make no mistake, we are not advocating allocating 100% into stocks. We believe the domestic economy has a lot of issues and there are still concerns about government debt in Europe. Of course, one negative news event and we could see lower prices in the markets.

However, most people have adjusted to this and are either completely out of financial markets or are completely in bonds.

What we are experiencing now is the polar opposite of the bullishness and euphoria prior to the debt crisis and real estate collapse. Only time will tell, but the pessimism seems to be deep and entrenched. While this negative sentiment could continue for some time, eventually it will break, the economy will improve, and markets will move higher. The key is in the timing - will this happen next month, sometime next year, or a few years from now?

Our prediction is it could be the latter, but that doesn't mean there will not be opportunities. We expect certain stocks, sectors, and overseas markets to outperform the broad US market indices over the next several years. From a big picture perspective, we want to think about the right time to begin deploying capital into these areas over the next few years, taking an opportunistic approach, and taking advantage of any volatility in the markets. Big opportunities come from acting against the crowd, not with them.

We still want to err on the side of protecting capital, but as time goes on we want to be less bearish and more opportunistic.