One-Hit Wonder?

 | Aug 16, 2011 | 11:30 AM EDT  | Comments
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This commentary originally appeared on RealMoney Pro on Aug. 16 at 8:28 a.m. EDT.

I remain of the view that Mr. Market hit a low for the year last Monday evening, but I am less certain that there is much upside now given the plethora of social, economic and market uncertainties. 

Below are some issues that limit upside to our markets from the current levels:

Politics as usual. The divisive and partisan circus in Washington, D.C. is likely to continue, especially since we are moving closer to the 2012 Presidential election. As a result it is unlikely that thoughtful and bold pro-growth fiscal strategies will be delivered any time soon.

* Moderate domestic economic growth. Over here, an already-fragile recovery has been weakened under the weight of nontraditional structural problems (middle-class screwflation, fiscal imbalances, a weak housing market burdened by a huge shadow inventory of unsold homes, structural unemployment etc.) The trajectory of domestic growth over the next two quarters remains uncertain.

* Weakening eurozone economic growth. Over there, a sovereign debt contagion and a weakening European banking system are likely to be exacerbated by the eurozone's economic stall reported last night (+0.2% second-quarter 2011 GDP growth). The most alarming part of the eurozone release was the sharp deceleration in Germany's growth rate (second-quarter 2011 slowed to +0.1% as compared to +1.3%). Importantly, the growth slowdown in Germany will likely materially reduce that country's support of a euro bond that would stem the debt contagion in Europe.

* Dependency on market valuation and government action. With these real growth issues (U.S. economic growth now uncertain and European economic growth near zero now), the health of the stock market is dependent upon valuation and government support. These are slippery slopes of optimism!

* Eroding confidence. Business and consumer confidence has cratered and is not likely to recover quickly.

* Technical damage. Volume accelerated to the downside but was milder on the upside -- never a good signal. The stock market, technically speaking, has been broken for now. It will take time to resuscitate the patient.

For these reasons and others, the odds favor that the Wednesday-through-Monday rally was a one-hit wonder. This doesn't mean that our investment world will come to a disastrous end. It is premature to call for a downturn in the world's economies, as, at present, a double dip still remains unlikely. Moreover, the health of the corporate sector (as measured by profitability and liquidity) has never been more solid. Inflation and inflationary expectations are contained, and interest rates will also be contained as far as the eyes can see.

Investor expectations are materially subdued, and investor sentiment is low. In the end, we all remain hopeful that, in the fullness of time, our leaders rise to the occasion in the current crisis.

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