Earnings season propelled the stock market in July, 2010 to its best month in a year, with the Dow gaining 7.1% as corporations continually shattered earnings estimates and revenue consensus. Technology (Apple, Intel), financial (Goldman Sachs, Wells Fargo), big oil (Exxon, Chevron), automotive (Ford), and most other sector heavyweights were weighing in with stellar quarterly reports. Containment of the Gulf oil spill as well as the passing grade received by 84 of the 91 European banks given the “stress test” also helped make July a winner.
Valuation of the market at large continues to be beneath historical levels. Although corporations are turning large profit and many are flourishing, it remains to see if July was a temporary reprieve of market mediocrity or a springboard to a rally that will bring share prices in line with value. I believe that the triangular depressive forces of unemployment, housing, and debt (both European and domestic), will continue to suppress the market for sometime and keep the market undervalued. This is bad news for those currently invested in the market, however, it provides nice entry points for the long-term value investor who has the opportunity to buy company shares at a discount.
On July 30th, it was announced that the United States gross domestic product grew at 2.4% for the second quarter, a number below first quarter growth as well as analysts’ expectations. On August 6th, the Federal Labor Department will report on the national unemployment rate, currently at 9.5%. Housing reports have continually been uninspiring, and the previously mentioned European stress tests of the 91 banks have been coming under increasing scrutiny that they were lenient and ultimately ineffective gauges. This continually tepid news continues to offset the corporate earnings successes, so the question is, what specific news has to come over the wires to get the market winning again?
Of course, any positive report tends to put the market up for the day, however what would trigger and sustain a rally? I believe that unemployment is the most important of the three depressive factors, and that it currently weighs as the largest bear. Not until unemployment falls under 8% do we have a chance to party like it’s October, 2007. There is just too much money on the sidelines and too much depressive mood when unemployment is this high. It appears that it will take sometime for the unemployment rate to get that low, however a surprisingly good number like 9.2 on August 6th would at least display that the United States is slowly but definitively putting people back to work.
Time will tell if the European banking stress tests had validity. If for example, Moody’s decides to give a downgrade to the financial health of one or more of the European nations, this will reinforce criticism of the test and re-invoke anxiety surrounding the global system. On the other hand, if negative news lays dormant and investors begin to gain some measure of confidence that the continent will not collapse; this will go a long way in reintroducing some panicked money back into the game.
People will be avoiding foreclosure, buying new homes, and increasing the value of their current home through renovative improvement when they are back to work. Home buying tax credits and record low interest rates have been unable to boost the industry because of high unemployment, however, at least a floor seems to have been established and pockets of increasing real estate value are beginning to appear in a small number of markets. In addition, homeowners have been able to refinance their homes at these record interest rates that have saved many a family from falling into foreclosure as well as bankruptcy, two positive points which strengthens that floor. But, not until reports surface that new homes are being built at generational baseline levels and homes are selling again will the market be in a position to reach its potential.
The fundamentals are in place for a bullish run. Hopefully, the preponderance of excellent corporate earnings translates into increased employment the way this correlation existed in the 1990’s. If the triangular forces of high unemployment, debt, and a poor housing market do not show improvement, it appears that we may hover in the 9000-11,000 range indefinitely. I do not subscribe to the bearish claims of Armageddon. Europe is not going to collapse, unemployment rates and housing appear to have bottomed out as they do now and again show flickers of light, and our domestic banking system is in much better condition than it was in the fall of 2008.