Spring Forward, or Fall Back?

Each December,
we pen our market expectation for the upcoming mid-year and year-end. Every
quarter, we like to revisit those views,
looking at which of our assumptions have proven to be either true or false.
With the winter of our discontent now over, let’s have a look at how our key
underlying assumptions – on Social Security Reform Employment and Interest
Rates – have played out:

Social Security Reform looked to have a solid chance of
passing post-election. Regardless of your views on the private account plans,
the prospect of 100s of billions of dollars in fund flow would have goosed the
markets – at least temporarily. Our mid-year Nasdaq target of 2620 and Dow
11,707 was in large part premised on some form of legislation getting passed.
There’s no other way to put this: The White House has dropped the ball, failing
to get any mileage even out of the surprisingly good Iraq elections. What
looked like a better than even chance of passage has slid to less than a 1-in-5
possibility. From our vantage point, Social Security Reform now appears to be

Employment surprised to the upside last month, but even that
positive number leaves us far below where we had hoped to be at this point of
the economic cycle. Wages remain soft, and job creation is overly-reliant on
Uncle Sam. As to the low unemployment rate, exhaustees and labor force
drop-outs make the unemployment rate appear much better than it actually is. It
is worse than even our pessimistic assumptions. A string of good Payroll
numbers (3 in a row) will allow us to revise this indicator upwards.

Interest Rates have ticked backed to where they were in the
first week of 2005. Fears of appreciably higher rates are certainly weighing on
the markets. The risk we have outlined (repeatedly) is the dampening effect on
the housing complex – which remains the most robust sector of the economy. With
a 7th tightening expected tomorrow, the Fed will soon be slowing down the
real-estate dependent U.S. economy by nearly as much as energy prices.

Given that our views on Social Security Reform and the
Employment outlook have proven to be overly optimistic, we are throttling back
our mid-year expectations. Our prior targets of DJIA 11,707, S&P 500 1,324
and Nasdaq 2,620 are each reduced accordingly: New DJIA midyear target is
11,215, SPX 1,255 and Nasdaq 2,470.

As we again stated last week,
as risk increases, it is a prudent course of action to reduce margin exposure
and where appropriate, marry puts to long positions.

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What's been said:

Discussions found on the web:
  1. JWC commented on Mar 21

    Interesting comments. Are you still anticipating a poor second half for the year with a drop in the indexes?

  2. Chris commented on Mar 21

    Unless I am mistaken this works out to roughly 6% in both the Dow and S&P and a bit under 23% for the Nasdaq. Since this amounts now to a 3 month forcast I am wondering how one squares what are pretty good return potential with your more conservative stance at this time?

  3. Duckbill Platypus commented on Mar 21

    The Iraqi elections were “surprisingly good” in a superficial sense only; not much has changed. Participation is meager; anti-American regional sentiment has abated only by the smallest increment. The current lower level of violence toward American soliders has not resulted in any increased stability. Plenty of innocent Iraqis continue to die. If Iraq eventually (hopefully?) becomes as Democratic as, say, Egypt (not an exemplar by any stretch), that’s not much of a victory. And neither is the continuously-growing multi-hundred billion dollar tab for this adventure.

    I don’t think this has any impact on markets other than news specifically about the Iraq oil supply. Now we know that worldwide growth in demand is so strong that even a “new Saudi Arabia” won’t make much of a difference. Watch out for news reports discussing the difficulty of ramping up oil supply and the unease about permanent US bases as policing Iraq morphs into the next stage. A new Saudi Arabia is precisely what Bin Laden wants to fuel his cause.

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