In this commentary we address some of the negative perspectives which contrast with our own more sanguine view of the stock market over the near to intermediate term. One of the more widespread fears is that the improvement in the economy in recent months is not sustainable, and we are headed for another sizable decline in both economic output and the stock market. A key rationale for this thesis is that the economy will weaken considerably once government stimulus dollars begin to abate. We do not share this view. Our belief is that financial crises are often crises of confidence, and therefore government efforts to stabilize the financial system can have an outsized impact beyond just the dollar amounts being spent. Additionally, certain fiscal stimulus efforts do have multiplier effects. For example, the “Cash For Clunkers” program clearly increased auto sales. This persuaded manufacturers and their suppliers to increase production rates which itself required additional hiring. The impact continues as these employees now have more income to spend which further benefits the economy overall. While this is just one example, it is illustrative of the positive impact that effective stimulus outlays can create.
Another concern is the health of the financial system. While we concede that there are still problem loans on banks’ balance sheets, policy efforts have had a strong impact here as well. Most of the key indicators that we monitor to determine confidence in the financial system (an example being inter-bank lending rates) have normalized considerably over the last several months. Additionally, it is our opinion that the increased scrutiny with which regulators are examining banks today has created far more clarity than normal regarding the health of the financial system. It is also comforting that the government has earned a handsome return on the portion of TARP funds which have been repaid thus far.
Lastly, many allude to the strong run that the market has had since bottoming in early March and fear that stock prices have gotten ahead of themselves. While it is true that the market has soared over 40% in recent months, we caution against putting too much weight on any one particular time period. One could just as easily point to the fact that even with the recent advance, the S&P 500 is still 35% below its October 2007 peak. It is probably more constructive to take a longer term view, in which case it is noteworthy that the stock market (as measured by the S&P 500) is currently at levels first reached in February of 1998. While we recognize that there is a reasonable likelihood for a short term pullback, we would view this as a normal and in fact healthy event which would require only minor tactical portfolio considerations.