Demi-Stagflation, Churning Markets, Tiring Bulls

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.

True stagflation
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
suffering thorough.

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.


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  1. JDA commented on May 17

    This is good stuff, thanks for all the good market talk lately.

  2. The Stalwart commented on May 18

    The Unagreed Upon Consensus

    The Capital Spectator: THE SPREAD SHALL SET YOU FREEA friend of mine who works at a hedge fund told me this weekend

  3. loret commented on May 18

    I find it amusing to read analysts who somehow still subscribe to the notion that the market discounts the future. So if the market is ramping higher, it means that it must be seeing something good in the future. And if the market is falling, it must be “discounting” bad news ahead.

    With the market ramping again today, many commentators are speculating that the bottom is in, the market has “priced in” all the bad news and that the summer rally has begun.

    Ok. Maybe so. But a quick check of history shows that three of the most powerful “summer rallies” occurred in 1929, 1987 and 2000—not years one would associate with sustainable bull moves.

    Was the market “discounting” good times ahead by rallying sharply during June-August of 1929, 1987 and 2000? No, it was just rallying while it could. The Dow rallied 30% from 6/1-8/31 in 1929. The SPX rallied 21% from 5/18-8/27 in 1987. The SPX rallied 16% from 6/1-8/31 in 2000.

    So maybe we get another miracle summer rally in 2005. But, if so, don’t forget to sell.

  4. Paul commented on Aug 15

    I think I finally now what they mean by sell in May and go away. My first dealings in the market were the summer of ’87. How great for a recent high school graduate to make such dough! It’s taken many years (decades) of ups and downs for me to realize many things about the markets. One of the most important bieng the seasonality. SELL IN MAY AND GO AWAY!!!! It doesn’t matter if you are talking about the S&P or Gold stocks it still holds true.

  5. reece commented on Oct 1

    where can i buy demi johns near pitsea

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