Monthly Market Monitor - December 2009

Markets Avoid Correction Thus Far
After pulling back slightly in October, most major market indexes gained ground in November. Corporate earnings and continued signs of the end of the recession were the main drivers of the gains. Some strategists are arguing that the market has decoupled from the underlying economy. While acknowledging improvement in the underlying economic conditions, they note that the markets have moved up much farther than these improvements warrant. A number of those with this viewpoint have been calling for a market correction, generally defined as a short-term pullback of approximately 5% to 15%. However, calls for such a correction have been heard for several months now and it has yet to occur. Other market analysts have thus far maintained that markets can continue to move higher due to improving economic conditions and the strength of corporate earnings growth. In addition to a return to positive GDP growth, they often note the low levels of corporate inventories. This is an important data point as an economic recovery would require many companies to rebuild inventories from depressed levels. This inventory rebuilding could further add to GDP growth. Of course, there is also the possibility that both things occur simultaneously. That is, corporate profit growth and economic conditions could continue to improve while markets experience a correction.

One investment that certainly has not seen price declines as of late is gold. Investors continue to buy both gold itself and gold related stocks such as mining companies. As gold is often seen as a safe haven from inflation (or potential future inflation), some analysts note that the metal’s recent run is mainly driven by inflation concerns. Another potential factor is the recent weakness of the U.S. dollar. Some investors could be selling assets that are hurt by a weak dollar and buying gold instead. A weaker dollar makes dollar-price gold more attractive for non-U.S. investors. Yet another possibility is that investors are simply buying gold because it continues to go up in price, known as a momentum trade. In all likelihood, it is a combination of these and other factors that are putting upward pressure on gold prices. Investors should keep in mind, however, that any reversal of such buying could send gold prices headed in the other direction.

Easy Money Continues
In its November meeting, the Fed left the Fed funds rate at its current zero to 1/4% range. There has been no change to this rate in all of 2009. The Fed first lowered its rate to the current level back in December 2008. The implication is that the Fed continues to believe that economic conditions are weak enough to warrant the existing low rate and that inflation is not yet a concern. On the more positive side, the Fed did say in its November press release that “economic activity has picked up.”² However, it noted several areas of weakness that prompted the decision to leave rates unchanged. These included weak consumer spending, ongoing job losses, lower household wealth, and tight credit conditions. For now, the Fed seems intent on keeping rates low in order to improve these negatives.

Eventually the Fed’s dilemma will turn to when and how much to raise interest rates as the economy gets better. The timing of such a move coming out of this recession is especially difficult due to the severity of the drop and the amount of overall stimulus that has been injected to improve conditions. Some strategists argue that the Fed helped create this past boom/bust cycle by not raising rates soon enough coming out of the 2000-2001 downturn. This in turn could make the Fed’s current predicament even more difficult. As evidenced by the announcements coming out of the Fed’s November meeting, the primary concern for now remains a potential false recovery. However, with more indications that the recovery is proceeding, this argument of when and how much to raise rates will develop as a major factor in what is expected be a more volatile market. Regardless of the timing of any Fed action, most analysts agree that the easy gains in the stock market in this upturn are likely behind us.

1. Wall Street Journal, 12/01/09
2. Federal Reserve, 11/4/09

The views are those of Cameron Lavey, Senior Investment Analyst, Research Department/ING Advisors Network, and should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy.

All economic and performance information is historical and not indicative of future results. The market indices discussed are unmanaged. Investors cannot directly invest in unmanaged indices. Please consult your financial advisor for more information.

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