The Advance is Permanent

Here we are three months since my last writing in this space. The market had nice gains in April, gave back most of those gains since mid May, and is now in the typical “summer doldrums.” That means low-volume trading and no conviction from the big players to move the market higher. Account performance is not giving any of us much satisfaction. Understandably, I’ve had several questions from clients about this year’s market behavior. While nothing I say in these updates will fully assuage the feeling of poor market performance to which we’ve become accustomed most of this year, I do have a reality check that I believe is very important to share with you.

Here is the historical reality of the last hundred years of stock market history: The advance is permanent, the declines are temporary.

As obvious as that might seem, it is very easy to forget when there are extended periods of bear market activity. That would be pretty much 2008 year to date. Look at any chart showing the market since 1908 and you will see an unmistakable trajectory pointing upward. The problem is, of course, that there are also downturns – which tend to be violent at times. Important to realize is this:

We tend to intellectualize the markets’ “normal” up moves (“ok, it was an up day today; that’s what the markets ‘should’ do”) and we tend to emotionalize the downturns (“ok, today was another down day. It feels like the DOW will never get back to 13,000”). It will, I assure you. And, as a contrarian, I believe it is most likely to do so when the “bear media” least expects it.

Here is one factor that might make it feel like the economy is slowing. One aspect of industrial production that has affected corporate spending is “ratio of inventory”: i.e. how much inventory is kept on hand to meet consumer demand.

The ratio of inventories to sales has been declining since 1982. In that year, there was 1.73 months of product in inventory on average for any given industry. That “in stock” number stood at 1.25 months supply as of April of this year. The good news is that this means corporations are no longer willing to take risks that consumer demand will slack off unexpectedly, leaving them holding millions of dollars of unsalable inventory. The bad news: to trim that inventory pipeline from 1.7 to 1.25 meant slowing down the production lines of goods and services. As this “just in time” production strategy has moved into America’s corporate mindset, it has actually reduced jobs needed in the manufacturing sector. This shortened inventory caused corporations to “wait on” consumers to drain inventories to the target ratio of 1.25 months. This is a good thing; it’s just a little painful on employment growth in the meantime.

Another example of why life is better now in America than it was in the “good ole days” is directly related to energy. Today’s economy is more flexible, fuel efficient, and competitive today than it was in the 1970s. As a nation, we produced ten times more in Gross Domestic Product (GDP) than in 1973. And yet, the energy used to produce those goods and services only rose by 35%! That statistic is from the Department of Energy and Commerce. It is unfortunate that the media does not choose to focus on uplifting data like that one.

So, yes, what I am saying is that optimism is the only plausible realism based on the facts. Said another way, the world does not end – it only feels like it is ending. Yes, the DOW will hit another new high. It may not be this month or even this year. But, unless one hundred years of market history are to be disproven, yes, the DOW will make a new high. And your portfolio, if invested well, will be carried along with that tide. Those investors that are “still in the game” (and not on the sidelines in cash) will be on the train when it bolts out of the station.

Moving onto another topic, starting in August, I will publish monthly online commentaries. You can subscribe to receive them automatically as they are published. Just look for the icon in the Educational Resources section on our website. I will still publish quarterly newsletters in print.

I assure you that Chris, I, and our team are watching your accounts daily as we evaluate how to best serve each of our client’s investment objectives. Please feel free to call or to email me (cbrown [at] weg1 [dot] com) with any questions or concerns.

Until next time,