Equity Market Outlook – March 2012

Overview.  Global equity markets are reflecting more confidence in the ability of the policy makers in Europe to avoid a catastrophic failure of Greek sovereign debt, and a possible meltdown of the European financial system in general. While the risk of that happening has certainly decreased, we don’t believe it’s a sure thing that we are out of the woods completely. We expect more headline risk in the weeks and months ahead, which will likely cause investors to once again reposition their portfolios to reduce overall risk.

Asset Allocation.  Over the last few weeks we’ve increased our allocation to the stock market, and reduced our allocations to both bonds and cash. Premium members and coaching clients were notified of the changes before we made them, as is our custom. Due to the highly constructive market action since October, we’re in the process of evaluating another change to the model portfolios.

Risks. There is plenty to worry about regarding the overall health of the global economy these days, but we still haven’t seen evidence of a new recession on the horizon. Stock markets have been rising for 5 months, and investors are wondering if the risk of a Greek default might be over. Should you follow the herd and buy stocks now? If you’re a short-term trader, then maybe you should. But investors who are primarily interested in building wealth over the long term should only increase equity exposure gradually, and at the margins.

Outlook.  The most likely scenario for the rest of 2012 is that the market will continue to grind higher, with occasional bouts of profit-taking spurred by scary news about Greece, the Middle East, the housing market, and unemployment. Our subscribers have slightly increased their exposure to the stock market, and as long as we continue to avoid another recession, they’ll continue to do so. For more information on our model portfolios, click here.

Perspective.  After nearly doubling since the bottom in March 2009 bottom, the stock market has gone through a series of normal (and much needed) corrections. One of the most frequently asked questions we hear is, why don’t we sell our stocks and avoid the occasional corrections in the market? The answer has to do with the difference between a recession-linked market decline and a non-recession-linked one. Our economic model is telling us that there is no recession on the horizon for at least the next 6 months. When the market corrects like it did in July – October, and there is no recession coming, we don’t sell stocks. In fact, in many cases we urge our subscribers to buy more.  That’s exactly what we did this time, to take advantage of fire sale prices on high quality stocks.

The fear of another global financial meltdown, accompanied by another crash in the stock market, is receding with each passing day. Our view is that the risk of a Euro-led meltdown is still present, but the odds of that happening have g0ne down.  Three months ago we put the odds of a Greek debt failure at 60%.  Today we think it’s more on the order of 30%.

The Big Picture.   After making an all time high of 1,576 in October of 2007, the S & P 500 declined by 57%, to 666 (on an intraday basis). It’s become increasingly clear that the bottom was made on March 9th, 2009. Since then, we’ve had a 52 month, 105% rally. After a nasty correction from July to October 2011, we’re now entrenched in another powerful bull move. While we don’t rule out the possibility of further weakness in the stock market, we believe the downside is much more limited than the upside. We’re looking for a range on the S & P 500, with 1230 as the low and 1410 as the high. It would take a significant worsening of the situation in Europe or the Middle East to change our low limit, and it wll take solid improvement in housing, employment, and consumer spending in order for us to raise the top of the range.

Investment philosophy.  There are two kinds of problems facing the market today. First, there are the tangible, systemic problems such as high unemployment, foreclosures, and very high government indebtedness. Investors who are pessimistic about the stock market are focusing most of their attention on these tangible problems. (We delve into these issues in detail throughout the site.) Then there are perception problems. There are many market pundits who are still predicting financial Armageddon, but we’re not among them. The equity market as a whole has decided that the risk of a total meltdown has subsided. The general perception among equity investors is that the economy is on the mend. In this market environment, perception is having more of an impact on prices than the actual numbers that are being reported. That’s because the stock market is a forward-looking mechanism that places more importance on the events that are likely to happen in the future, than the ones that are right on top of us.

The longer term recovery in the economy and the markets is likely to be pretty bumpy. The structural damage that has been done to our economy by the global meltdown of 2008 will likely take several more years to heal. The days of 15 – 20% annual equity market returns are behind us, and probably will remain so for several more years. But we continue to believe that the policy response to the economic crisis has been correct. It’s now likely that we will see continued improvement in both GDP, and equity prices for at least the next 12 months.  While we may be near the upside of our price range for the equity markets, we think it would be a mistake to count on a major correction and avoid equity exposure.