Tags: david | frazier | Stocks | Bottoming

Stocks Have Likely Hit Bottom

Tuesday, 21 September 2010 11:24 AM

While the “gloom and doomers” like Nouriel Roubini continue to talk about the likelihood of a double-dip recession, the recent action in the stock market suggests that stocks have likely bottomed.

Meanwhile, several economic indicators suggest that the worst is over for the U.S. economy and that the economy will enter a sustainable period of slow, but steady, growth during the second half of 2011.

For example, the S&P 500 Index has traded sideways since the final week of May even though worldwide economic conditions worsened during the past few months.

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Separately, investors withdrew a relatively small amount of money from stock mutual funds during August in spite of the fact that the Dow Jones Industrial Average fell last month below the psychologically significant level of 10,000 for the third time this year. Specifically, investors withdrew approximately $11 billion from stock mutual funds during August, as compared to $24.8 billion this past May.

Those developments suggest that investors have factored most, if not all, of the “bad” news into the markets and that stocks are in the process of bottoming.

In regard to the economy, numerous economic indicators suggest that the U.S. housing market will remain weak through the middle of next year and that Americans will limit their spending to necessary household items rather than spending indiscriminately on unnecessary discretionary products and services. However, those same statistics suggest that the housing market will improve and that Americans will increase spending during the coming year.

For example, inventories of newly constructed homes fell sharply during July while sales of newly constructed homes fell to their lowest level since at least 1963 (when the U.S. Department of Commerce began collecting data on of home sales). Specifically, inventories of newly constructed homes relative to the population of the United States declined during July to a level that was 26 percent below their previously lowest level on record. (Inventories of previously owned homes also fell sharply during the past two years).

The fact that the construction of new homes remained near historic lows during August suggests that inventories of homes will decline further during the months ahead. That would be a positive development, if it were to occur, because home prices tend to rise when inventories fall, thus leading prospective homebuyers to purchase homes before the pries of such homes rise to restrictive levels. In turn, increases in home purchases lead homebuilders to increase their construction of homes, which forces those builders to increase the sizes of their workforces. Hence, the employment situation tends to improve during periods when homebuilders increase the number of homes that they construct.

Meanwhile, recent foreclosure statistics indicate that the pace of foreclosures will slow during the coming months. For example, the percentage of mortgage loans that entered foreclosure proceedings rose only 6.3 percent during the quarter ended June 30, as compared to the same quarter a year ago, while foreclosures rose at a year-over-year rate of 20.3 and 38.8 percent, respectively, during the quarters ended March 31, 2010 and December 31, 2009. Prior to the fourth quarter of 2009, foreclosures had risen at a minimum pace of 50.5 percent during every quarter since the current recession began during December 2007.

The fact that the median price of previously owned homes is currently near its lowest level in more than six years and that mortgage rates are currently near their lowest level since at least 1971 also supports the likelihood that both the construction and sales of homes will begin to trend higher as soon as the employment situation shows signs of improving.

That would be a very positive development for the direction of stock prices because stocks tend to bottom approximately six to nine months before the construction of new homes bottoms.

Meanwhile, several economic statistics suggest that Americans will increase their spending on all types of goods and services during 2011. For example, Americans have made substantial improvements to their household finances since the onslaught of the credit crisis that began during 2007. In fact, the household debt of Americans as a percentage of their after-tax income declined during July – the latest month for which data is currently available – to its lowest level since November 1998.

Separately, recent comments made by, and actions taken by, the Federal Reserve indicate that the Fed will increase its efforts to maintain low borrowing rates during the months ahead. Hence, there’s a good chance that personal-consumption expenditures, which account for approximately 79 percent of the total output of goods and services in the United States, will trend higher than their current levels as soon as the employment situation begins to improve.

Although I expect the economy to grow at a slow pace during the coming year, the factors and developments mentioned above suggest that the U.S. economy will be much healthier during the next several years than it’s been since the 1990s.

In light of the fact that stock prices tend to bottom approximately six-to-nine months before overall economic conditions bottom, my experience suggests that now is a good time to begin to position your investment portfolio for a likely improvement in the economy during the coming year.

However, the current readings on several technical indicators – indicators that reveal the trading action in the stock market and investors' demand for stocks – suggest that stock prices in general will pull back considerably during the next few weeks.

Note from Moneynews:

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About the Author: David Frazier
David Frazier is a member of the Moneynews Financial Brain Trust. Click Here to read more of his articles. He also writes two very successful investment newsletters. Discover more by Clicking Here Now.

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While the gloom and doomers like Nouriel Roubini continue to talk about the likelihood of a double-dip recession, the recent action in the stock market suggests that stocks have likely bottomed. Meanwhile, several economic indicators suggest that the worst is over for...
Tuesday, 21 September 2010 11:24 AM
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