Streetwise for Sunday July 5, 2009

Streetwise

Lauren Rudd

Sunday, July 5, 2009

It's Summer and the Living is Easy - Maybe

It is summertime once again and the living is easy, or at least it used to be. The calendar says that summer officially started a few days ago, yet for many of us the season kicks off with the celebration of Independence Day.

In the past, July 4 has meant the official start of the beach and barbecue season, while others view it as a time for a well earned vacation. Unfortunately, this year many of you will be forced to forego a vacation due to economic circumstances.

Yet, regardless of circumstances, each year at this time everyone always asks the same question...will the stock market treat us to a summer rally? Summer rally, heck if the markets would just escape the jaws of the bear chances are most investors would be waving flags and jumping up and down.

So what is the likelihood of a summer rally? Statistically, 73 years of data show July as being the best month for stock prices in terms of percentage gain. Furthermore, the Dow has rallied during 57 of the past 64 summers. Of course, if you subscribe to the theory that the stock market represents a series of independent events, then a rally has exactly the same statistical probability as no rally. Nonetheless, many long-time observers of the stock market concede that there are certain seasonal tendencies.

Of greater importance this year is the precept that Wall Street is a forward looking indicator for the economy. In that case you could rightfully argue that the road ahead for Wall Street, while it may have a few potholes, is likely to be a positive one.

Probably the worst among those postholes is unemployment, a key reason for the lack of demand in the economy. Last January, despite overwhelming opinion to the contrary, I stated that we would see a double digit unemployment rate by the end of the year. According to a recent statement by the White House, the rate will hit 10 percent in the next two months.

That is the bad news. The good news is that the unemployment rate is usually the last of the major economic indicators to show improvement as you exit a recession. Therefore, when the rate begins to decline, which I believe will begin to happen in the first half of 2010, you will know that some solid economic growth is underway.

Furthermore, improving economic conditions during the second half of this year will likely mean higher equity prices with US stocks outperforming European stocks and emerging markets outpacing developed markets for the year.

So what about the omnipresent inflation genie? As Business Week adroitly pointed out, ever since the late economist Milton Friedman wrote in 1963 that "inflation is always and everywhere a monetary phenomenon," central bankers have been on notice that printing too much of the green stuff jeopardizes their legacies as guardians of sound money.

Yet, the Federal Reserve has increased the nation's monetary base by 114 percent over the past year through May. Is Fed policy just asking to set loose the inflation genie upon an unsuspecting public?

The answer is an unqualified no, and furthermore the increase in the monetary base may not even be large enough. Understand that the inflationary effects are being fully offset, or perhaps more than offset, by household debt repayments. Households are paying down debt and saving more.

The people who worry about inflation have not fully grasped the ramifications of this multi-trillion dollar extended deleveraging. While paying off debt is a good for the long-term health of the economy, in the short-run it impairs consumer spending and consumer spending accounts for about two-thirds of our gross domestic product.