The Prospects for a Shiny New Quarter

10/01/2010 9:54 am EST

Focus: MARKETS

Jim Jubak

Founder and Editor, JubakPicks.com

What a difference three months make. The bear market we had expected didn't show up—but don't start singing “Happy Days Are Here Again” just yet.

It's a new quarter.

Do we know any more about the trends in the stock market and the economy than we did at the start of the previous quarter?

Actually, a little bit. I don't think we're at bet-the-farm certainty, but figuring out the trends isn't quite as confounding as it was three months ago.

Partly that's because three months ago the market and economy were truly baffling. When the bar is so low, "mildly conflicted confusion" is a big improvement.

But partly it is because the trends in the financial markets and the economy actually seem reasonably clear as we begin the fourth quarter.

A Bear? Turns Out, No

Let me start with a quick survey of the bad old days of July 1, then move into my list of what we know and what we don't as we investors try to figure out how to navigate the fourth quarter of 2010. And because I like crawling out on a limb and then taking my Husqvarna to it, I'll give you my best guesstimate on how certain it is that we know what we think we know.

Remember where the market stood at the start of the third quarter? Stocks had been caught in a pretty steady downdraft since the April 23 high of 1,217 for the Standard & Poor's 500 Index. The index then bottomed on July 2 at 1,023, rallied to a high of 1,128 on August 9, and tumbled again, to 1,047, on August 26.

For much of the quarter, it looked like the rally that began in March 2009 was over, kaput, stick-a-fork-in-it done. With the July-to-August rally ending August 9 at a high so much lower than the April high of 1,217, and with the market seemingly determined to head for an August low below the 1,023 of July 2, it sure looked like we were headed for one of those lower-high, lower-low patterns that tell you worse stuff is on the way.

But instead, the market pulled up short of setting a lower low in August and proceeded in September to move back to 1,128 and then above the August high. And suddenly what looked like a high probability of a move from a bull to a bear market looks now like it was just a correction.

The Trends Are Looking up

That brings us to the end of the third quarter and to my survey of what we think we know for the fourth quarter:

  • The technical trend in stock prices is pointing very solidly up. On September 28, the Dow Jones Industrial Average moved to just 3% below its April 26 high. In the past few days, other indexes have moved up to confirm the Dow trend. The NYSE Composite and Nasdaq Composite indexes, for example, are both in uptrends on rising volume. The Russell 2000 Index has closed above its August high.

The Dow transportation index rose September 28 to its highest close in four months. That's important confirmation for the move in the Dow industrials, since transportation stocks move up when investors think the economy is improving. There may be bumps along the way from, say, third-quarter earnings reports in October, but the trend says stocks will be higher at the end of the year than they are now.

Certainty that this trend is what we think it is: 80%

  • The economy is strong enough that another recession isn't a worry, and consumer buying is, if not strong, better than expected. Here the most recent data come from shipping companies FedEx (NYSE: FDX), United Parcel Service (NYSE: UPS), and Delta Air Lines (NYSE: DAL). All are reporting pickups in traffic to stores, signaling a better-than-expected holiday shopping season.

Now we're not talking dancing-in-the-streets enthusiasm, mind you. Delta, which carries more air freight than any other US airline, told Wall Street that it projects a "perfectly decent" holiday season. FedEx, the second-largest package shipping company in the world, calls its shipments "solid."

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Retailers do seem to be restocking inventories in anticipation of a decent holiday shopping season. Toys R Us reports that it will hire 45,000 holiday workers, 10,000 more than last year. (Those will be temp jobs, granted, but still, the company is hiring. And hiring above the levels of last year.)

Projections from the retail group at Deloitte say holiday sales from November through January will climb 2% from 2009 levels. Hardly a bonanza, you might say, but holiday sales rose just 1% in the 2009 season. A decent holiday shopping season would be good for investor morale and for stocks.

Certainty that this trend is what we think it is: 70%

  • Businesses will keep ordering capital equipment. Orders for capital equipment, the stuff that companies buy to expand or improve their businesses, rose 4.1% in August, according to data from the Commerce Department. Orders for nondefense capital goods excluding aircraft—the most useful measure to watch if you're trying to predict the pace of business investment—has climbed at a 15% annual rate over the past three months. That's down from the 24% annual rate for May, June, and July but certainly isn't the kind of drop that you'd expect if businesses were expecting a double-dip recession.

Certainty that this trend is what we think it is: 70%

  • Short-term interest rates are low, and they're going to stay low. Longer-term interest rates are low, and they'll likely head lower in the quarter. The Federal Reserve has made it clear that it thinks there's no need to fight inflation in this economy and that it will bias monetary policy toward increasing the economy's growth rate. That means no increase in the short-term rates controlled directly by the Fed and at some point a return to buying Treasurys to depress longer-term interest rates.

Lower interest rates, all else being equal, are good for the economy and for stocks—in the short run.

Certainty that this trend is what we think it is: 99%

  • The official unemployment rate is unlikely to significantly budge from its 9.6% rate. Even if the job market picks up, there are more than enough discouraged workers looking to re-enter the work force to keep the unemployment rate high until way into 2011.

Government layoffs are a huge factor in the lack of progress: States and cities are cutting their work forces as lower tax revenues lead to budget deficits. But private-sector employment is picking up. Private payrolls grew by 67,000 in August and are projected by economists to show growth of 50,000 for September. That's enough to give investors (if not consumers) hope that the jobs picture is headed in the right direction, albeit at a horrendously slow pace. It's certainly not enough to produce economic growth of much better than 2%. But that's probably enough to boost stocks in the fourth quarter, since expectations for growth are so low and fears of another recession still so high. But it does make me worry about 2011, when 2% growth is likely to be greeted with exasperation rather than relief.

Certainty that this trend is what we think it is: 80%

  • Housing prices are the other big drag on the economy. If you don't have a job (or are afraid of losing one) and the price of your house is falling, you just aren't going to rush out to the store. That's especially true when the number of foreclosures is still rising. Lenders foreclosed on 95,000 homes in August, a record. Although the number of initial notices of default dropped 30% in August, it will take some time before that trend translates into fewer foreclosures. And right now the tide of foreclosed properties on the market is a major force in preventing any recovery in home prices.

There's some evidence that housing prices may have bottomed, but there's no reliable projection for how long home prices will bump along the bottom. I think this picture takes most of the growth out of a substantial piece of the US economy—construction, home improvement, white goods, and construction machinery. And that's one more reason to think that while growth will be decent enough in the fourth quarter, stocks and the economy will be challenged again in 2011.

Certainty that this trend is what we think it is: 50%

  • Everybody knows the dollar is in the tank, so a falling dollar isn't going to arouse a lot of fear among investors.

And in the fourth quarter, it's even likely that against the euro and maybe even the yen, the dollar won't be quite as big a dog as you'd expect from looking at our budget deficit. (More like a Labrador than a Great Dane.) That's because in the short run of a quarter, the euro crisis is going to continue to make that currency look even riskier than the dollar and because the Japanese government, out of ideas for reviving the Japanese economy, will intervene in currency markets to weaken the yen.

The dollar will, of course, continue to weaken against the currencies of commodity-producing economies such as Australia and Canada, and that in itself will boost commodity prices for buyers using US currency. Gold will continue to climb in the quarter on the general turmoil in the market for the world's big currencies.

Certainty that this trend is what we think it is: 70%

What We Can't See Can Hurt us

None of this means there aren't potential surprises lurking in the quarter. For example, a slowly simmering euro crisis could worsen enough to present financial markets with Greece II. That would produce panic selling of financials again. I think the likelihood of that is small for the fourth quarter and 2011 but greater for 2012 through 2014, when several euro economies, including Greece's, face big refinancing bubbles.

Beijing could make a major misstep and cut back too hard on growth in order to slow bank lending. But again, I think that's more of a worry for 2011 than for the fourth quarter of 2010. Same with the US budget deficit and Japan's no-growth economy and aging population.

Enjoy the relative clarity of trends in the fourth quarter. At this point, 2011 looks like a return to the murk.

At the time of publication, Jim Jubak did not own shares of any company mentioned in this column in his personal portfolio.

Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.

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