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Second Quarter 2009

The markets had a spectacular run the last three months.  From the devilish March 9^th low of 666 the S&P 500 has rallied to a high of 946, which is a 40% rise.  The market was oversold during the panic low and has rallied too far too fast.  We will almost certainly have a correction (sell-off) --  which is normal, expected and healthy. 

The economic conditions are much more favorable now than back in March when we didn’t know which companies would survive.  The picture is clearer now, even though the market will probably decline this summer.  We should consider a retracement of half-way back as a buying opportunity. 

The most powerful factor underlying both the economy and the stock market is the massive amount of additional money supply about to flow into the system.  We have had four monetary infusion cycles in the last hundred years but none  as large as this one,   which was created by the Federal Reserve initiatives, legislated stimulus and  cooperation with world central banks. Presently less than 10% of this historic monetary infusion has worked its way into the economy. When the full effect takes hold, which always takes longer than we want, asset prices including real estate, basic materials and stocks will rise.  Inflation and higher interest rates always follow such a huge creation of money.  The outcome has always created higher equity prices, but the inflation side has to be managed carefully. 

We are beginning to hear about the gigantic debt that our country is taking on in order to finance the various stimulus packages and the inevitable monetization of that debt.  Debt monetization occurs when a nation’s central bank buys government bonds.  For example, take a government that is running at a deficit and has expenses of $100,000 and collects taxes of $80,000.  It finances the deficit by selling $20,000 in government bonds.  Monetizing the debt means the treasury now prints an additional $20,000 in crisp new $100 bills and buys back the $20,000 in bonds it previously issued.  What happened is the central bank (in our case the Federal Reserve) created new cash to pay off the deficit.  

This process is inflationary.  The Fed has stated that it will do whatever it takes to stop deflation and reinflate our economy.  I would not bet against that, but their plan to deal with the ensuing inflation is to deal with that problem later. 

The bottom line is that in the short term we will see some market pullback and correction of the quick 40% rise from the low of March 9.  Further out, when the monetary infusion takes hold, asset prices will rise; and after that the trade-off will be inflation.  Those who are timid and put their money under the mattress will struggle to pay their food bill five years from now. Assets should be placed in investments that will rise with the increased money supply and inflation. 

The Economy.  The Conference Board uses ten “Leading Indicators” to predict how strong the economy will be in the coming nine months.  The Leading Economic Indicators have begun to rise for the first time since last year, suggesting that although the recession will continue in the near-term, a return to growth will likely occur in 2010.

The Gross Domestic Product (GDP) is a measure of total output of goods and services produced in the United States.  It is compiled by the Bureau of Economic Analysis.  Jobs are contracting and the banking system has slowed to almost no activity, confirming the

recession which economists say began in December 2007.  Real GDP declined at a rate of 6.2% in the fourth quarter of 2008, and declined again in the first quarter of 2009 at an average rate of 5.5%. 

The Consumer Confidence Index hit another all-time low in March 2009 at 26.0.  The erosion of the Consumer Confidence Index reflects the rapid and steep deterioration of economic conditions that occurred in the fourth quarter of 2008.  The consumer by himself will not contribute to the economy any time soon:  only government stimulus will help at this point.  The Index now stands at 49.3: a significant improvement since March. 

Market Valuation.  The unprecedented market events during the last year have made it nearly impossible for analysts to predict the S&P 500 earnings.  The figures being talked about are no more than educated guesses.  Using a figure of $60.00 for 2009 and a multiple of 15.5 produces a year-end valuation for the S&P 500 of 930, which is about where we are now.

Market results for the second quarter of 2009 were: