Is This the End of the 2009-2011 Bull Market?

Investors questioning whether this is the start of a bear market or a buying opportunity

     

Last week, the Dow closed below 12,000 for the first time since March 18, after falling for six straight weeks. That hasn’t happened since the week ending Sept. 30, 2002, but that was at the tail-end of a 30-month bear market — a great historic buying opportunity.

Compared to the dismal days of 2002, the recent six-week decline has been small (-6.8%). Last year, the S&P fell much further (15.3%) from April 29 to July 1, but then it rose 33% in 10 months. In this latest sell-off, data from EPFR Global tells us that retail and institutional investors withdrew the most money from U.S. mutual funds of any week since August 2010. But selling stocks then, before the launch of QE2, was also a bad move! So what’s next?

Global Growth Should Resume Once Japan Recovers

The global economy is still expanding, but at a slower pace. Investors are selling stocks because they are concerned about the U.S. economy after the Fed suddenly ends its second round of quantitative easing (QE2) this month. It’s hard for the market to recover when so many investors used Thursday’s rally as an excuse to run for the exits (and perhaps a long weekend in a cooler place) on Friday. This malaise could last another few weeks, until we see positive second-quarter earnings announcements come mid-July.

Fortunately, thanks to a weak U.S. dollar, second-quarter corporate earnings are expected to remain strong. There were a few analyst downgrades last week, but those downgrades were predominantly in the troubled retail sector. When investors finally realize that a weak U.S. dollar helps corporate earnings, due to all the multinational stocks that dominate the S&P 500, the stock market will likely firm up in July.

The Commerce Department announced Thursday that the April trade deficit narrowed by 6.7% as imports from Japan declined by a record 40.8%! In particular, auto and auto part imports from Japan declined sharply. Many economists, like Ed Yardeni, are convinced that the Japanese earthquake and tsunami threw a big monkey wrench into global growth, causing trade to dry up. The good news is that the Japanese Purchasing Managers Index (PMI) surged to 51.3 in May, up from 45.7 in April. Since any PMI over 50 signals growth, Japan has apparently regrouped after the earthquake and tsunami in March.

Although the Japanese PMI is finally rising, similar indexes in China and the United States are dangerously close to falling below 50, which would signal a contraction. Due to the Japanese parts disruption, U.S. durable goods orders fell for the third straight month and vehicle sales stalled. Consumers are also shopping less, since the average household must now spend $183 more per month on food and energy. However, Japan’s May recovery suggests that the rest of the world economy could follow Japan’s lead fairly soon.

Last week’s Federal Reserve Beige Book backed up this analysis. Specifically, the Beige Book discussed how the Japanese earthquake and tsunami caused a serious supply chain disruption for the U.S. economy. This implies that when Japan’s supply chain returns to normal, economic growth should return to normal.

Even though Ben Bernanke has expressed some caution, many other Fed governors expect a return to robust growth in the second half. In an interview with The Wall Street Journal, Charles Evans, President of the Chicago Fed, said he expects the economy to grow by 3% to 3.25% in 2011, and 3.5% to 3.75% in 2012. In addition, Dallas Fed President Richard Fisher recently said, “I would like to see 3%-plus growth in the second half (2011) and I think it is achievable.” And finally, Philadelphia Fed President Charles Plosser sees 3% to 3.5% growth in the second half, adding that “soft patches are not that uncommon.”

 
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