The extremes in the market in the recent past – overbought in mid-April and oversold just a couple of weeks ago – have dissipated. Volatility has fallen and the market has held support at a critical point 4 times, which is a good sign. It is not unusual (actually it is expected) to have a correction of greater than 10% in a bull market, especially when the initial run up stage has been completed. A correction in a bull market takes out some “froth” and rebuilds the market for the next up leg. The oversold/overbought conditions we look at are shorter-term indicators and currently show that the market is still oversold, but not at the extreme level they were just last week. The recent action in the market over the last few days is encouraging as we have seen lower volatility and steady upside performance.
Some clients have become very concerned about problems in the US and around the world. Yes, we agree that there are some major hurdles for the future: high unemployment, the potential collapse of the Euro, Middle East tension, increased government spending, inflation expectations, etc. These issues are real and significant. This cautious outlook by individual investors is why fixed income assets were at record levels in the month of May. However, investors that jumped out of the market early last week may have made a critical mistake. The market, as defined by the Dow Jones Industrial Average, is still 26% below its all-time high, is currently trading at a reasonable valuation, and should continue to see earnings surprise’s on the upside. US companies, growth companies in particular, have balance sheets that are in the best shape in decades and are cheap relative to the peers on the value side of the ledger. Additionally, interest rates are still very low and, in our opinion, will continue to be low for an extended period. Looking at the chart below shows the returns of various asset classes compared to the average investor. One can quickly see what short-term emotional decisions can do to the returns of the typical stock market investor.
Source – J.P. Morgan Guide to the Markets 2Q 2010
Our technical analysis of the market shows that the long-term uptrend of the market is still intact. Our analysis though requires us to be vigilant on a daily basis, looking for signs that might indicate a reversal of the current trend. The number one signal that would give us pause is if we started to see short term interest rates starting to rise. We don’t expect to see that in the near future. This may be the start of the proverbial “Summer Rally”.
Your THOR Team
P.S. – If you get a chance, please give a warm welcome to our newest employee, Susy Hisch. She will be taking Mary Ann’s place at THOR and will likely be the first person you speak with when you call into THOR going forward.