Friday, February 5, 2010

Storm Warnings for the Market

I'm not ready to give up on this market yet, but I must confess I'm getting a little nervous.

Company fundamentals continue to show some improvement. A number of earnings reports this week were solid, even if management guidance was cautious (e.g., Emerson and Cisco). Today the unemployment rate dropped back below 10% (although the economy still lost jobs in January), which could help psychology.

However, I think the credit problems of Greece and Portugal are only a foreshadowing of bigger problems in larger countries, like the U.K. And yesterday Moody's announced that if the U.S. did not start making progress on cutting our budget deficit, then even our debt might be downgraded to AA.

Governments around the world are being forced to go on a spending diet. Taxes around the world are being raised, and new regulations are being proposed on almost a daily basis. In short, government policies are becoming less stimulative, and potentially restrictive.

Why would government fiscal problems hurt the stock market?

Here's my thought. The massive rally in stocks that occurred last year was in large part spurred by easy Fed policy and huge fiscal stimulus, in my opinion. Now all of the talk coming from Washington is about cutting spending, and removing some of the Fed intervention from the credit markets.

Can the "real economy" pick up the slack? Maybe, but most consumers are focusing on debt repayment, and consumer spending represents 2/3 of the economy. A deleveraging world probably means lackluster growth.

Again, I'm not ready to cut just yet - stocks in general are still selling at reasonable multiples, and the alternatives to stocks (i.e. bonds) offer too little yield to be attractive longer term investment vehicles. Interest rates remain historically low, and M&A activity is clearly increasing (e.g. Kraft/Cadbury; Air Products/AirGas).

We had a nice late day rally this afternoon, so maybe my concerns are overdone...let's hope so.