The stock market has made some really remarkable gains over the last two months, but are these gains actually sustainable? And do they imply that a full recovery is underway?
In the short term, I would have to say yes. My reasoning is twofold.
#1 Inventory restocking. Most businesses operate on a cylindrical cycle, meaning they have fluctuations in both profit and sales. Over the past year economic data has been very poor. People in general have all shared a pessimistic outlook for the economy. In turn, this meant that many businesses were reluctant to purchase new inventory, putting off reordering for months because sales were forecast to be very slow. The past few months have shown companies finally starting to reorder new stock, providing a momentary increase in manufacturing and sales. However, its important to note that these companies are still nowhere near to ordering the same volumes as they were in previous years – this is simply due to the fact that customers still just aren’t buying as much. However, no matter short or long, I believe that for the next quarter or two, economic data should turn positive based on this inventory recovery.
#2 High Unemployment. Unemployment remains at the highest level in a decades. As many of you may have heard in the news, unemployment is traditionally a lagging economic indicator – meaning that unemployment follows stock market movement, albeit on a delayed path. However, Wall Street interprets high unemployment as good news and now you should too. The reasoning is because when economic data looks grim, many companies layoff many employees to cut back on costs, citing the grim and uncertain future. But fewer workers on the payroll results in lower costs. Since companies are still cutting payrolls, another 216,000 jobs in August to be exact…, while the economy is stabilizing, corporate profits will be higher than expected in the third quarter. And that means a higher percentage of revenues will reach the bottom line as profits. For the short term this again implies that company earnings will be announced ahead of analyst expectations, creating greater gains for the upcoming quarter.
But how does the long term look? In all honestly, I think It’s still hard to see a sustained pickup in demand and economic growth with unemployment still rising and with the real unemployment rate – the rate that includes all those who are unemployed, underemployed (working part time but looking for full time work) – at a horrible 17%.
And my current interpretation of the data ignores the possibility that the signs of economic recovery we’ve seen really just represent companies rebuilding inventories they sold down during the worst of the recession. If that’s the case, demand will weaken again as companies finish rebuilding their inventories and don’t reorder because consumers, worried that so many are out of work, don’t return to buying.
Conclusions? If you’re a long term value investor looking to buy and hold, you may want to continue waiting on the sidelines for a few more months until more news comes out stating that the economy has stabilized. But if you are looking for some quick short term gains, have the appetite for risk, and stomach to handle volatility, buy now and get ready to pump and dump in the coming months.
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