The global economy is growing. But if you listen to the news media, and especially if you listen to the typical blogger, it's easy to become convinced that the global economy is in a downward spiral. The recovery is intact, but it's slow going. The consumer is still trying to dig out of the debt hole, and unemployment is painfully high. But government spending, inventory restocking, and business spending are enough to keep growth going until the consumer comes back.
Is this a correction, or something more?
We've had a 15% correction since April. In order to qualify for the textbook definition of a new bear market, we would have to see a 20% or greater decline. While this is certainly not out of the question, we think the odds of a double-dip recession accompanied by a bear market are low - perhaps 15%. Therefore we're playing this as a correction, and we made the necessary changes to our asset allocation models last month to reflect this view.
Unsustainable rally in the bond market
The bond market, especially the U.S. treasury bond market, has rallied as a direct result of the global "flight to safety" trade. Nervous stock market money has flooded into treasury bonds, causing prices to spike higher and yields to decline. We don't think this will last. As market participants become more confident about the resolution of the Eurozone sovereign debt crisis, they will gradually start to drain some of that money away from bonds and put it back into riskier assets. If you are currently over-invested in bonds, we think now is a good time to lighten up. If you are nervous about stocks, you can park your bond money in cash temporarily.
Commodities are weak, and for good reason
Commodities have been battered. Partly due to a fear that China's growth will slow down, and partly due to fears of a "double-dip" recession, almost all of the commodities we track are down 10%, 20% or even more in the last 6 months. The weakness in commodities seems more justified to us, given the announcements by the Chinese that they are trying to moderate growth, and given the potential for slower Eurozone growth as a result of austerity measures. We think the selloff in commodities is close to being overdone, and we're getting ready to increase our allocation to commodities. But it's too soon to pull the trigger yet. Stay tuned.
Currencies are being re-aligned
The dollar is rallying big time, primarily as a result of the "flight to safety" trade. The Euro is under trememdous pressure as investors flee from a possible sovereign default. This is an indication of fear, and in our opinion, it's not sustainable. There may be some further weakness in the Euro, but we're looking for an oversold bounce. And any talk of dollar-euro parity is just wild speculation based on a complete meltdown in Europe.
Pay attention to the business cycle
As always, our stance on the markets, and our asset allocation models, are driven primarily by the business cycle. As long as the cycle remains healthy, we see no reason to change anything. If the markets correct out of pure fear, we view it as an opportunity to buy underpriced assets. But if we see fresh evidence of a possible turn in the business cycle, that would be very different. If that were to happen, we would have to revisit all of our assumptions about growth and value, and we would be much more open to the idea of reducing exposure to the stock market.
"Those who wait for every problem to be solved before investing will be buying closer to the top than the bottom." - Jeff Miller, Seeking Alpha
