Posted by Shyam Moondra
The stock market is in a downward spiral. Since April 26, 2010, when the market set the 52-week high, DJIA has declined over 12%. After having risen 74% from the crash bottom set on March 6, 2009, it was expected that the market would have a correction. However, the intensity of decline (as much as 25-30%) in the prices of shares of some of the companies in the financial and technology sectors is baffling. The market decline lacks conviction given the relatively light trading volume. The market sentiment has become overly negative, which may be a sign of the market bottom. Every little bad news gets overblown and good news gets discounted. In the last couple of quarters, the economy has been recovering steadily as is evident by the statistics on corporate profits, industrial production, leading indicators, consumer confidence, retail sales, and housing. The numbers on inflation have been very positive. When did stock market decline in an environment characterized by increasing corporate profits, low interest rates, and low inflation?
At the present time, the investors have lost confidence in the strength of the economic recovery, largely based on fear and misconceptions. Here are some observations:
· When an economy comes out of recession, it does not recover in a straight line. Initially, it's always a slow process consisting of two steps forward followed by one step backward. That's quite normal as the economy goes through the phases of structural adjustments during the post recovery period.
· The Europe debt problem is being blown out of proportion. The U.S. banks have no more than $60 billions worth of exposure to Europe, which is like a drop in a bucket, considering the size of the total assets of these banks. It's doubtful that there will be any defaults on sovereign debt, so long as the countries are prepared to tighten their belts and IMF is ready to help them out. Yes, in the near-term, reduced government expenditures would slow down the European economy a little, but the budget cutbacks will have very healthy long-term impact in terms of keeping the interest rates low and in keeping the economic recovery going on a sustained basis. So what is going on in Europe is not as bad as some fear-mongers would like us to believe. In fact, today, Germany announced that manufacturing orders in the month of April unexpectedly rose 2.8% compared to the previous month; this was a good news but it apparently got lost amidst the panic driven market decline.
· In the last two months, the economy has actually created new jobs. The unemployment rate is a lagging economic indicator, so obviously this is the last category of improvement we would see as the economy recovers. The data for the current year has nothing in it that would suggest that the economic recovery is getting off track. The employment numbers reported in the coming months would prove that. While it is true that it may take a few years before we again see the unemployment rate closer to 4.5%, let us not forget that 90% of the workers are currently employed and they have done an extraordinary job in controlling their spending and saving more during this recession than any other prior recessions.
· The corporations have $1.5 trillions cash on their balance sheets, which is a record. Some of this cash will end up in capital investments that will create new jobs. The corporations did a very good job in controlling their costs throughout this recession (via low inventories and painful work force reductions); as a result, the productivity gains would contribute to their higher profit margins as the economic recovery gains momentum.
· The pace of innovation picked up even during the recession, as is evident from the new products being offered by technology and other companies. There were hundreds of people waiting in lines for hours in London and Paris to get their hands on Apple's iPad. Doesn't that say loudly that one should never underestimate America? The U.S. has always been on the forefront of innovation and we will continue to dominate the world and create high-paying jobs. One has to have faith in what we can do.
Given the American entrepreneurial spirit and genius, one can never doubt where we are headed. The current pessimism and fear are misplaced. The beaten down stock prices are in fact an excellent opportunity to invest for the long-term. The market correction has run its course and it seems ready for a big up move.
