Don’s Outlook 9/25/09
After pausing last week, stocks ran into additional headwinds on Wednesday, and the weakness has continued until today. The selling began soon after the Federal Open Market Committee released its September 23 statement, which concluded its two-day meeting. Fed officials upgraded their assessment of economic conditions and were even more optimistic about their outlook for growth, expecting “a gradual return to higher levels of resource utilization.”
The quick reversal on Wednesday that followed the much anticipated release was traced back to trading action in the US dollar. For the past six months the dollar has gradually weakened, reflecting the resumption of risk taking as investors sold their stable US dollar and treasury holdings and reentered the stock, commodity, and corporate credit markets. This is expected to continue, but any perception that the Fed is ready to raise rates or that the stock market will correct is likely to strengthen the greenback in the short term.
The decline in the dollar has thus far been rather benign, returning us to the point we were just one year ago. Although the arguments that large budget and trade deficits, as well as low savings, have debased the US currency are valid and may prove the route cause of sustainable weakness, this year’s reversal has more to do with the “carry trade,” which leads investors to borrow low-yielding currencies in order to invest at greater returns elsewhere.
The headwinds to stocks this week also included mixed economic data, some of which surprised to the downside of expectations. Both existing and new home sales fell or missed consensus estimates, causing investors to question the pace of recovery. Also, durable goods orders dropped in August after having risen in July. This helped to reverse the positive sentiment from Monday, when the index of leading economic indicators climbed another 0.6 percent in August, its fifth consecutive monthly increase.
The gains in stock valuations since March have been justified given the improvements in economic indicators and the expectations for future corporate earnings. Additional price movements from here will be driven by positive macroeconomic news and the third-quarter reporting season, which has been trending higher. The earnings per share estimates for both 2009 and 2010 have climbed 20 percent.
The auto industry is one driver of this growth: light vehicle production could be 47 percent higher in the second half of 2009, and output should continue to rise over the following three years in order to make up for the dramatic decline experienced since 2008. Firms exposed to the industry, such as auto parts suppliers, will be a direct beneficiary, which is why I remain positive on Fidelity Select Automotive (FSAVX) in the near term.
