Two weeks ago, we noted that the SPX and Dow had reached the top of their trading ranges. We suggested at the very least a retracement of the August 13 to September 15 rally was due. Further, the break we were looking for below 1123 has produced our expected pullback towards 1105. As those levels get hit, the markets will become oversold, at least on a short term.
As we wait for that to play out, investors are left pondering the meaning of the lower highs and lower lows of 2004: Is this a Bear market, or are we merely digesting 2003’s outsized gains? With the quarter ending Thursday, and the indices flat to down for the year, one certainly cannot make the claim that this is a powerful Bull market. Yet the range-bound trading hardly proves the Bear case.
Our conclusion? We are working our way through a post-bubble, post-stimulus economy. The Nasdaq remains more than 60% off from its highs. We continue to suffer the hangover from the bubble’s aftermath: Capacity utilization is lingering in the ~75% area, thanks to all the overbuilding and over-investment from the ‘90s. End-user demand remains anemic, and manufacturers find themselves unable to pass along price increases, despite the rising prices of many commodities.
All this suggests to us that economic growth will remain in the modest 2.75–3.5% range. Inflation will primarily be found in commodities, as opposed to wage pressure. Job growth will continue to be mostly mediocre.
With or without further stimulus, the U.S. economy requires additional time to heal and work off the excesses of the bubble. How much time? Following the popping of the Japanese bubble in 1989, and the 80% drop of the Nikkei Dow, Japan was mired in an economic hangover for 14 years. But the Japanese central bankers made the mistake of cutting rates somewhat gradually. They allowed a deflationary mentality – postponing purchases as prices slid – to take hold amongst their consumers.
That doesn’t appear to be happening in the U.S. Our central bankers produced more monetary stimulus, and in a faster timeframe, than did their peers across the Pacific. So far, we appear to have dodged the deflation bullet. But that doesn’t suggest that we are out from under the post-bubble environment.
As such, we continue to look at the markets as presenting trading – but not investing – opportunities. Modest support exists at SPX 1100-1105 — and if we get extreme sentiment readings at that level, we would be buyers, albeit with tight stops loss points.