Don't let the doom and gloomsters pull you down

By David Schwartz 12:40 25- Mar -2009

The economic news is poor. Investors are frightened. But well-hidden below the surface, a number of clues suggest stock market prospects for the future are looking positive.

The UK stock market had been drifting within a well-defined trading range since last October. But a sudden dip drove priced down through the bottom of the range. The news headlines that accompanied this decline had a decidedly negative slant as well.

When prices eventually stopped falling a few days later, many investors (myself included) were quite unnerved.

It is easy to panic at times like this and close down all open positions. Experts call it “capitulation”. The opposite error is to ignore fresh facts and stubbornly hold on to obsolete views. Either approach can lead to painful trading errors.

As always, at times like this, I try to avoid either error by ignoring headlines and studying the underlying facts. Apologies in advance for sounding like Pollyanna, but I continue to feel optimistic about stock market prospects for the rest of 2009 despite dismal economic conditions.

A good starting point is to compare the performance of the FTSE 100 and the 250. The Footsie is chock full of large financial institutions. It fell 20 per cent in 2009 at its recent low on March 3. In contrast, the FTSE 250 fell just 9 per cent as of this day and remained well-above its own November 2008 low. A decline of this size is painful of course, but not a calamity. Those who avoided financial shares were not too badly hurt

Another issue worth thinking about is the state of the US economy. Let’s face it, if improvements to American economy boosts Wall Street, our stock market will probably rise as well. A good example is last Monday’s explosive US rally which pulled up our own market as well.

There are a number of fresh economic statistics coming from the US that have positive implications, despite the negative news headlines surrounding each of them.

A good example is the all-important unemployment report. The most recent release of this monthly series tallied 651,000 fresh February job losses. There was much hand wringing by analysts but few attempted to place this figure into perspective. Little attention was paid to revised unemployment counts just issued for January (655,000) and December (681,000). The monthly data had been rapidly declining for most of 2008. The recent plateau is a refreshing change.

Data from the last few months suggests the speed of decline is slowing. The current unemployment rate is currently over 8 per cent. I have little doubt that it will get worse. But a recent Bloomberg survey of top-notch economists forecasts a 9.4 per cent peak. In other words, we may be approaching the bottom on this economic indicator.

Recall that unemployment is widely believed to be a lagging indicator. It often bottoms out after the economy begins to improve.

America’s Institute of Supply Management offers similar positive clues. Plateaus or slight declines were evident on several recent economic activity measures.

The positive effect of US tax cuts and vast spending plans are also worth considering. They will help to end the economic decline even if some of the spending is misguided or politically driven.

The Blue Chip Economic Indicator newsletter offers hope as well. Many private economists now believe the US economy will begin to grow in the third quarter of this year.

Given that the stock market typically anticipates the future, these economic figures are good omens for investors around the world. For this reason, I remain positive for my 2009 trading prospects despite dismal current news.

Investor sentiment data is also reassuring to contrarians like me. A recent survey by the American Association of Individual Investors yielded its highest-ever bearish reading. Virtually every media commentator believes any bounce-back rally will be short-lived. This level of negative sentiment often precedes a solid bounce.

Let me quickly temper my positive views. I do not expect a rip-roaring stock market recovery. The combination of rapidly rising consumer savings, weak labour productivity and tight credit conditions will slow economic growth. Looking further ahead, government stimulus could eventually trigger high inflation and rising interest rates.

But these are tomorrow’s problems. The rest of 2009 looks good for investors..