We’ve been watching this market from the sidelines, and
we cannot help but wonder what is going through the minds of investors. Are
they looking at the recent choppy action as a buying opportunity? Or as we
suspect, do they find this to be a frustrating range-bound affair, where each
step forward is met with one and half steps backwards?
In particular, we’ve taken note of the markets as they
churn up and down, making little if any progress. Each time the indices move
forward, they seem to do so on lighter volume and decreasing breadth. This
reveals a lack of institutional participation. Each attempt at climbing back
into the prior trading range is met with more supply. It is not only
exasperating to the Bulls, but is a recipe for exhaustion.
What’s behind this? As mentioned last week, it’s a
belated recognition that growth has slowed while inflation has not. However,
despite all the “stagflation”
chatter we’ve heard lately, we do not believe we are in any danger of those
specific unpleasant circumstance. Rather, I suspect we should prepare ourselves
for a case "demi-stagflation" – anemic growth and robust
inflation. I expect this condition may persist through out the rest of 2005.
is far less likely than has been feared. The current environment simply
isn’t conducive to the unusual economic numbers of the 1970s. I doubt we will
see 7% inflation and a 1% GDP rate anytime soon. But that doesn’t mean the
environment is ideal; far from it. We may possibly see GDP at 3% or just below,
while inflation is at 3% or just above. That translates into Growth just
a little bit too soft, and Inflation just a little bit too robust.
The fact that both economic indicators are on the edge of being acceptable is
why the market has been such a battle lately. Neither side has the clear
advantage. Hence, the churning and directionless affair we have all been
Inflation more robust than growth presents a challenge
for equities. As these two perils bite into consumer and business spending,
margins and revenues will be pressured alike. Eventually, that reduces
earnings. The recent shift to the lower trading range is due to the recognition
of this new paradigm. Assuming no P/E expansion takes place– and why would it
in this environment? – in order to maintain the same P/E for the S&P500,
equity prices must slide lower.
That process is now well underway, and it’s why I believe that the present attempts to re-enter the prior trading range will be unsuccessful. We still await more attractive levels to become buyers.