Trend: The S&P 500 is up over 50% since early March, while most of the measures of the U.S. economy show weakness. This gap between the stock market and the economy cannot continue indefinitely.
Either the stock market will be pulled down by the weak economy, or, the stock market is a leading indicator and the economy is starting to rebound.
If you believe that the economy will pull the stock market down, you will be prepared for a downturn. On the other hand, if you feel that the stock market is indeed a leading indicator and the economy will start to rebound soon, you will be investing in "bargain" stocks for the run up.
If you lose 50%, you must gain 100% to get back to even! :-(
However, if you lose 20%, you must only gain 25% to recover.
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You can find experts and indicators to support both views.
The Optimistic View
Optimists see the new bull market "climbing a wall of worry" that will drive stock prices much higher. The Fed has made all the right moves to prevent a financial collapse. The recessionary pressures are easing as consumers are starting to spend again. New home sales have stopped dropping. The Leading Economic Indicators have turned up. So far, 480 of the S&P 500 companies reported earnings. Total earnings are down 28% from the 2nd quarter last year. But an amazing 73% of the companies posted better than expected earnings. Only 9% were in line with expectations and a very low 19% failed to meet or beat expectations.
The Pessemistic View
Pessimists warn that the real problems of the economy have not been solved by the Fed's easy money policy, by the big bank rescues or by the stimulus programs. The aftermath of the financial crisis — too much bad debt, overleverage, a sick banking sector, and an over-stretched consumer — are still with us. The rally has been strong and it is showing signs of slowing down, but it’s hardly unprecedented. The greatest stock market rally in history makes the current run-up look quite tame: in 1932 the Dow soared 111% in just 98 days.
Bottom Line
Stock market commentators may say the recession is over, but local and state economic indicators do not support that assessment. The stock prices of companies that are dependent on consumers and businesses in the United States cannot grow faster than the fundamentals of those companies for an extended period. If the economy rebounds, we would expect stock market gains to moderate. However, if the economy does not improve, we would expect the U.S. stock market to be pulled down by the revenue weaknesses of the underlying companies.
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