The stock market has sunk by 10 percent from the March peak periods. Back in March, I alluded to a likely topping off in the stock market because of impending soft economic data over the horizon. Read that blog entry here >
With an understanding that forecasting is a hazardous sport with many misses, I will attempt to make another call on the stock market. The current correction is likely coming to an end. The basis for this projection is principally due to
- The U.S. economy is in no danger of an impending recession
- Corporate profits are sky high with huge cash reserves sitting on the sidelines
- Greece dropping the euro will devastate Greece, but not others
After every recession there is a recovery. The current problem is that expansion to-date has been frustratingly slow. But America is in no danger of falling into another recession of the GDP falling for two consecutive quarter or net job losses occurring for several consecutive months. The key is that housing market is recovering. Increased home sales and housing starts leads to income generation and induces many secondary spending impacts, such as at furniture stores and for lawn care. Housing, or more formally called residential construction spending in GDP accounting, will be growing by 13 percent in 2012 and a further 18 percent in 2013. Such a growth rate will be pushing up the GDP by at least 0.5 percent points going forward, which is much better than the net negative that occurred during the housing market bust periods. With housing recovery and the fact that the overall national income is rising at 2 to 3 percent, it is hard to foresee how the U.S. economy could go into a recession. One notable short-term subtraction to the economy is the cuts in government spending. When jobs are cut at state and local government levels, there is less money circulating in the local economy over the short haul. However, an improvement to the government finances will help long-term economic growth. The U.S. economy (GDP) is therefore forecasted to rise 2 to 2.5 percent in 2012 with job creation to the tune of 1.5 million to 2 million this year and the next.
The second factor that will help support the stock market from sinking further is that corporate profits are at a record high. The latest $2 trillion is more than double the amount in late 2008. The stock market valuation in the end is a reflection of profits, current and future, and given the high current profits further declines in the stock market is not necessary.
Finally, the Greek problem will be limited. Germany, the European economic powerhouse where people retire at the age of 60 to 65, has no interest in helping out Greece where many people retire with good pensions at the age of 55. The borrowed money to pay for the generous pension will soon end. Greece, whether from its own choice or from being forced upon from outsiders (as no new loans are provided), will leave the Euro currency. The Greek Drachma, its former national currency, will return. Unfortunately, the value of the Drachma will be essentially worthless, so the Greek citizens will suffer a drastically lower standard of living. Fortunately though, other countries with high debts, such as Portugal, Spain, Ireland, and Italy will witness the harm of leaving the Euro and they will quickly understand that there is no such thing as a free lunch. Economic restructuring of Portugal, Spain, Ireland, and Italy will then help these countries as well as the broader global economy. Greece will take a longer time to recover, but its weak currency over time will draw many tourists to travel to Greece on the cheap. The bottom line is that Greece will be an isolated problem and not a big European problem that can meaningfully alters the global economy.
The bottom line: U.S. economy expands, though slowly; jobs get created, though slowly; home sales continue to do better this year compared to the last; and finally already high corporate profits will rise even more. Therefore, a further measurable stock market correction is no longer required. Keep in mind, however, that the stock market has repeatedly proven to be highly irrational, with big, unjustifiable ups and downs over the short term.