“Well, I’m not even sure that’s a crime anymore…” Fletch, 1985

By David B. Armstrong, CFA | Oct 25, 2010 | Weekly Market Commentary

News of it taking $363b to prop up Freddie/Fannie as well as mortgage documentation woes hitting a large bank for a -4.5% weekly loss were not enough to keep the market from continuing to rally last week.  Friday marked the sixth positive week out of the past seven for the markets.

BUT – while stocks were higher last week, there is some concern surrounding the current rally.

The Dow Jones Industrial Average (DJIA) finished the week above 11,000 again by gaining 0.63% to finish at 11,133, the S&P 500 Index gained 0.59% to finish at 1,183 and the Nasdaq Composite Index gained 0.43% to finish at 2,479.  The Russell 2000, which measures smaller capitalization stocks, was essentially flat at 703.43.

Recent economic data has been lack-luster lately, and we are still waiting to see some movement on the employment front. If unemployment stays at 9.5% through 2011, it will have been at this level for three full years. It’s disturbing that there has not been any sort of material decline in this number.

Additionally, mortgage applications declined last week and remain at a very depressed level – if you have any doubts about this, just ask anyone with a ‘for sale” sign in their yard.  This, despite record low mortgage rates, is starting to weigh on the sentiment of investors.

As we have said before, the stock market could be the one great piece of stimulus needed for the economy.  However,  we think that the rally will stay muted relative to last year’s rally until investor sentiment increases to the next level.  This will likely take improvements in the employment and the housing markets, though.

The key risks to the current rally are:

1. Future increases in the foreclosure rates – if we see foreclosures increase, the chance of a double-dip recession increases.
2. State and local budgets tip into a crisis – when asked why he could not “find the money” to build the N.J. side of a new tunnel, Gov. Christie of N.J. stated, “I can’t print my own money like the federal government.”  These budget shortfalls present a risk.
3. Bush Tax Cuts – there is a risk they will not be extended as we enter the New Year.  Even though they may be retroactively extended, paycheck withholdings will automatically start creating an economic drag and negative sentiment.

There are still positive factors contributing to the economy as well.  These include the strong third quarter corporate earnings and the expected quantitative easing that should be announced after the November elections.  So far this quarter, 30% of the S&P 500 companies have announced earnings and solid sectors include Tech and Materials.  There have also been noticeable improvements in top line revenue as well as bottom line earnings.  Increasing revenue is key given the cost cutting that has taken place over the past 18 months.

Please let us know if you have any questions.

Securities and Financial Planning offered through LPL Financial, a Registered Investment Advisor.  Member FINRA/SIPC

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