New Market Commentary

May 26, 2009

Stock Market Update

After a rally of more than 30% since the March lows, the stock market appears to have entered a corrective/consolidation period. The market is somewhat constrained at the 880-920 level for the S&P 500 for two reasons. Some observers believe that fair value for the S&P 500 is at the 900 level and for the market to move higher; new, positive developments are needed. Secondly, the 200 day moving average of stock prices is just above current levels and creates a barrier to the market’s advance. A corrective/consolidation period in the weeks ahead may eventually enable the market to build a sufficient base to crack through the 200 day moving average, at which time a rising trend in the market might be perceived as developing, something more than a bear market rally.

Given this setting, it is appropriate to assess the pluses and minuses of the outlook for the market. The pluses are: The risk in the market is that it will continue to rise and discount in 2009 any fundamental improvement in 2010 and 2011. Supporting this view are positive monetary forces producing a liquidity driven market. As long as the economy’s performance is tepid, excess liquidity, created by the Fed, will find its way into markets. This continues to be the most positive factor supporting stocks. Any pull back in liquidity by the Fed, which might alter the liquidity driven nature of the market, is not likely to occur until the economy gains more strength than is likely before year-end. Cash reserves remain high and earn little return. Many investors are underweight stocks. Consequently, potential buying power remains significant. Cyclical forces are positive for the market with fiscal stimulus now joining monetary stimulus. Government reflationary polices are becoming more substantive in support of the economy. Meanwhile the market generally acts well in the face of bad news and financial conditions are improving as spreads are narrowing reflecting increased risk taking. Earnings growth expectations have begun to recover from very depressed levels. Managements are reining in costs, setting the stage for meaningful margin improvements as and when volumes begin to grow. While the market averages have not surmounted their year-end 2008 highs, the breadth of the market has broken out to the upside. The fact that a clear majority of stocks are rising over those falling is a positive indication of the markets future trend. A broad market is bullish.

On the minus side, stocks generally are no longer compelling values. Positive liquidity forces and increased confidence about future profits is needed now to support higher stock prices. The economy is likely to recover slowly due to constraints on consumption. Nonetheless, severe cost cutting could enable profits to perk up on any pick up in volume. The employment market is likely to weaken further and foreclosures and bankruptcies will rise through year-end. Commercial real estate is under pressure adding to the woes of residential real estate. The stock market is overbought and may correct/consolidate for a time. Worries later this year will be whether Bernanke will be reappointed chairman of the Fed in 2010 and the role of the Fed vis a vis the Treasury, the two seem to be linked more closely than in the past. Other than an outbreak of protectionism, the great worry for the market would be the politization of the Fed by the current administration.

Our conclusion is the market is in a cyclical bull phase while the secular trend is still in a bearish trend. This view translates into a trading range for the S&P 500 of 750-1100 in the months ahead. A return to 600-700 would require major new negatives that are not apparent today. In the context of this setting, portfolio strategy should be more active than passive. We do not foresee a return to the 1980s and 1990s which are defined by an extended economic expansion and the longest bull market in stocks in the country’s history. Investment should be more global to capture growth outside the U.S., especially in Asia. Growth stocks of all kinds have been leading global markets and we believe this trend will persist. Other than growth stocks, equities of companies having pricing powers, such as natural resources, should perform quite well. Finally, it is a good idea to build in inflation protection for the future. Over time the dollar is likely to decline and inflation is likely to rise.

A. Marshall Acuff, Jr., CFA
Managing Director
Chair, Cary Street Partners Investment Committee
Cary Street Partners Investment Advisory, LLC