Monday, May 23, 2011

Will There Be A Second Half Rebound?

Both NDD and I see a slowdown occurring right now. The question for both of us now is, will the economy snap back? Consider this articles reasoning as a possible answer to that question:


Stocks, commodities and other risky investments have sold off in recent weeks amid worries about slowing global economic growth. But the relatively tame downturn in stocks is evidence that many investors expect the rally to resume in the coming months.

These investors don't expect the market to match its powerful rally in the first four months of the year, when the Dow Jones Industrial Average was up 10%. Instead, they are betting that the economy will rebound from a sluggish patch and nudge markets higher at a more restrained pace.

The expected catalysts for the rebound are lower energy prices, caused in part by the slowdown itself, and gradual improvement the U.S. job market. In addition, corporate earnings and balance sheets remain healthy, which should provide support for both the economy and a floor for stock prices.

The optimism does have a deja vu feel about it. Call it the myth of the second half. Every year, no matter how the market does at the start, investors convince themselves their losses will be erased or their gains magnified by a strong second half.

.....

"The markets are asking the question as we see growth slowing, 'do we trace that into growth becoming negative or into growth slowing and then accelerating?' " says Noah Weisberger, head of macro equity strategy at Goldman Sachs Group. "Our core view remains that we reaccelerate, but until that becomes clear the markets may be worried."

Mr. Weisberger says slowdowns in the middle of economic recoveries are common, and Goldman has broken them down into three parts: deceleration, stabilization and reacceleration. Right now, the economy is still decelerating from its strong snapback at the start of the recovery. Mr. Weisberger is waiting for the shift from deceleration to stabilization, at which point Goldman will recommend that investors make riskier bets.

Until then, investors should be braced for whippy trading at least through midyear and acknowledge that riskier investments could fall further before recovering. The modest downturn in the face of bad news may itself make the market more jittery. The Dow Industrials are down just 2.3% in May even though they just finished their worst three-week stretch since last August.

The article hinges most of its argument on lower gas prices. This is in line with Professor Hamilton's research on the topic. However, prices will have to drop for a significant length of time -- that is, they must drop long enough to change consumer behavior.