Streetwise

Lauren Rudd

Sunday, July 1, 2012

And the Living Is Easy

It is summertime once again and the living is easy...or at least it used to be. The Fourth of July is the unofficial start of the beach and barbecue season. It is also when everyone asks the same question...will we see Wall Street produce a summer rally between July 4th and Labor Day.

Statistically, July is the best month for stock prices in terms of percentage gain. Furthermore, the Dow Jones Industrial Average has rallied during 59 of the past 67 summers. And the preponderance of data indicates that the stock market is subject to seasonal quirks.

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. And there is no doubt that the annual expectation of a summer rally is partially the consequence of the fiction and fantasy that always seems to envelop stock trading.

At its worst the folklore simply contributes to the market's overall mystique. Yet, long-time observers of the stock market concede that the stock market does exhibit seasonal tendencies.

Of greater significance is that Wall Street is considered to be a forward looking indicator for the economy and currently the financial markets seem to portend potentially difficult times ahead. One quandary is the high level of unemployment and its symbiotic sister, consumer demand. Or more specifically the lack of consumer demand.

Downturns occur when total spending on goods and services falls significantly short of the economy's productive capacity, meaning that consumption and private investment are depressed.

Consumption spending will remain well below its 2007 peak because spending at that level was never sustainable to begin with. Much of it was financed by home equity loans based on artificially high home prices. Americans must have thought they hit the housing lottery when every week, they received multiple offers to tap into their home equity.

At the same time Wall Street banks convinced global investors that a property equating to a toxic dump was truly worth half a million dollars.  Trust us they said, we are from Wall Street!  Many of those that participated lost their homes.  Yet, investment bankers did not have their yachts repossessed! Today home equity loans are like spotting a bald eagle in the wild.

So how do we make up the shortfall? Businesses are unlikely to increase spending short-term because they can already produce more than people want to buy. Therefore, the only remaining actor with the capacity to make a significant difference is government.

What about that nettlesome inflation issue? Ever since Milton Friedman wrote in 1963 that "Inflation is always and everywhere a monetary phenomenon," central bankers have been on notice that excess printing of money jeopardizes their guardian legacies.

No argument. However, as Richard Koo so carefully elucidates in his book, “The Holy Grail of Macro Economics,” we are facing a balance sheet recession, meaning that the mantra of the day is debt reduction. With the demand for borrowing diminished, low interest rates have a muted effect, thereby keeping inflation well under control. At the same time if the government fails in the arena of fiscal policy the economy will continue to languish.

Now before I ruin the start of your summer vacation, let me add that as opposed as I am to short-term market forecasting, I believe Wall Street has a better than even money chance of looking beyond the current economic difficulties with a view towards a smoother road up ahead.

However, the market’s performance is not the key determinant of your portfolio’s performance. There are always profitable investment opportunities available if you are willing to expend a modicum of time and effort to find them.