This blog post originally appeared on RealMoney Silver on July 9 at 8:05 a.m. EDT.Since I have been out for a few days of meaningful and persistent downside pressure, let's frame the market expectations that have led up to my current outlook for stocks over the balance of the summer and into the fall. Like Shakespeare's Polonius, I adopted a neutral view of U.S. equities in late May in a column entitled " Neither a Bull nor a Bear Be." As stocks continued to rise, I argued in early June on CNBC's "The Kudlow Report" that, while I remained confident that a generational low would not likely be breached for years (if not forever), equity valuations had nonetheless more than discounted the second derivative improvement in the economy, and stocks were running ahead of the real economy. In addition, I further opined a month ago:
- More tangible signs of economic traction are necessary before the markets move higher.
- The trajectory of economic growth will be shallow and will likely disappoint the equity markets during the second half of 2009.
- Massive cost cutting has resulted in better-than-expected first-quarter 2009 profits, but it holds a downside as significant employee layoffs (and a still-weakened consumer) threaten the seeds of domestic economic growth over the intermediate term.
- Savings rates will remain high, and personal consumption expenditures will remain low for an extended period of time.
- The specter of rising taxes and higher interest rates in late 2009/early 2010 will likely impact an already fragile recovery in the economy and in the markets -- a double-dip is due then.
- Near term the market looked increasingly exposed and the upside was certainly capped.
Looking beyond the near term, I would emphasize that I view the two correction scenarios as bolstering the market outlook during the fall-winter period. Both scenarios would serve to build up skepticism, shake up complacency and make it difficult for many investors to have the nerve to get back in.... A subsequent rally out of these two scenarios would be fueled by investors chasing strength as even in bear market rallies (1938-1939), there is typically more than one leg higher. By contrast, a continued rally would expose the markets to a more serious correction.Stated simply, I see the current correction as a normal reaction to a seismic rally from the unprecedented and compressed levels of early March.
-- Doug Kass, " Three Summer Scenarios" (June 22, 2009)
My Updated and Current Market ViewConsistent with my expectations of a sideways correction, the world's stock markets appear to be poised to go to sleep for the balance of the summer. Over the course of the next two months, I expect the S&P 500 to trade in a relatively narrow range of between 850 and 925. Here's why I find that there are few catalysts that would move the market in any meaningful direction from current levels:
- Second-quarter earnings will produce little in the way of surprises. While being nothing to write home about, corporate profits should continue the trend of the previous quarter, exhibiting tepid top-line sales growth, but profits will be buoyed by drastic cost cutting.
- Market participation should be especially light. Not only is it summertime, but the wounds of 2007-2008 must be allowed to heal. Long weekends (taking off Fridays) will likely grow longer (as many will also take off Thursdays or Mondays).
- Macroeconomic statistics should continue to stabilize, but the progress should not meaningfully deviate from consensus expectations. Housing will be aided by lower pricing, a continued improvement in affordability and in a reduction in the cost of home ownership relative to renting. The replenishment of manufacturing inventories will stoke modest third-quarter GDP growth but will be muted by a large output gap. Employment statistics will get "less worse," but, again, the recovery will be modest in scope and settling of the double-dip debate will linger. All in all, the principal signs of economic activity that I expect to be reported in July through September will not be enough to produce an upside surprise but neither will it be too little to generate meaningful downside momentum in equities.
- With little in the way of substantive change in economic growth expectations, commodities, too, should be on snooze mode.
- Political initiatives should be modest in July and August as our leaders take leave of Washington, D.C., and also vacation.
- I expect little in the way of hedge fund or mutual fund flows (inflows or outflows) to generate a material change in the supply and demand for stocks, and with fixed-income prices (and yields) exhibiting limited fluctuation, the reallocation of pension plans into stocks and out of bonds will likely ebb in the months ahead.
- With valuation arguably at an historical mid range, P/E multiples seem to be reasonably fair and not subject to a major move in either direction.
- It's hard to see a meaningful swing in sentiment under the aforementioned muddle-along economic setting that contains few surprises.
Know what you own: Some of the most active stocks in Thursday's midday trading include Bank of America (BAC), SPDRs (SPY), Financial Select Sector SPDR (XLF), Alcoa (AA), Citigroup (C), PowerShares QQQ (QQQQ) and General Electric (GE).