Now that August is behind us, the only certainty is that the market’s direction appears quite uncertain. The S&P 500 Index, a proxy for the market, has posted negative returns in three of the last four months, concluding with a drop of 4% in August. The economic backdrop has softened and the recession to recovery momentum has decelerated—or even in some areas reversed. After the S&P 500 Index peaked at a recovery high of 1217 in April, the market is now within shouting distance of the standard bear market definition of a 20% decline. Indeed, the warm summer months of 2010 have experienced a severe market chill.
Because of the heightened uncertainty over the short term, I believe that the prudent strategy is to be somewhat defensive until the economic conditions stabilize and clarity improves. While there is the chance for the market to reverse its multi-month retreat at any time, the more likely scenario is a continuation of decelerating economic conditions, a flat-to-downward pressured market, and pessimistic investor sentiment. As a result, remaining cautious over the short term is the likely best course of action.
Despite all of the near-term negatives stacking up, I continue to believe that the economy is unlikely to fall back into a double-dip recession and the market is poised for an end-of-the-year rally. Where we are now, at approximately 1080 on the S&P 500, the market does appear fairly valued, if not undervalued. Corporations confirm these attractive valuations by increasing their acquisitions of targets in order to buy up rivals and complementary businesses at these attractive levels. Businesses continue to slowly invest through capital spending and the consumer has proven remarkably resilient even in the face of mounting unemployment and a tough housing market.
There are many catalysts that loom on the horizon that could be the elixir that the market is seeking.
- Key market levels (10,000 for the Dow Industrial Average and 1040 on the S&P 500) are being tested now, which could rally the bulls if held or confirm the bearish momentum if broken.
- The Federal Reserve Bank meets again in late September and could provide a jump start to this economy with further stimulative monetary policy moves.
- A clarity rally could also be sparked once the uncertainty surrounding the outcome of the midterm elections clears.
Nonetheless, the risk is to the downside over the short term; consequently, tactical portfolios should opportunistically position for increased volatility and the likelihood for the market to move to the lower end of its near-term range. While I remain optimistic that the market will close the year at higher levels than we sit today, the path will be a long, winding one. More importantly, the path currently lacks clarity and, until the economic conditions stabilize to confirm the recovery will not reverse into a double-dip recession, prudence will likely be the best portfolio management technique. As always, please contact me with any questions.
Greg Powell, CIMA
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This research material has been prepared by LPL Financial.
The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.