Blog : Ain't No Cure for the Summertime Blues

by Ed Zwirn on August 4th, 2014

Wall Street has managed to snatch defeat from the jaws of victory.

This much is clear: If you were invested in the stock market last week, chances are you lost money. It took only one session (Thursday's) for stocks to lose any ground they may have gained in July. The Dow Jones Industrial Average lost 2.8% on the week, the NASDAQ 2.2% and penny stocks, as per the Russell 2000 Small-Cap index, off 2.6%.

But the fact that investors are feeling the pinch begs the question of whether we are seeing the start of a major market rout or a healthy pullback (and therefore another "buy on the dip" opportunity).

Here are a few reasons to favor the more optimistic of these two outlooks:

-- For one thing, there ain't no cure for the summertime blues. Like the song says, you can take your problem to the United Nations, but there is no escaping the fact that the warmest season tends to be the most punishing for stocks. This may not sound scientific, but August almost always leaves investors licking their wounds. Like other so-called calendar effects, there are varying explanations for this, none of them entirely satisfactory, and there is no guarantee that they will carry forward, but, as I pointed out a couple of months ago in this investment blog, the expression "sell in May and go away" has been coined out of hard, bitter experience.

-- For another, both the economic news and earnings updates have recently all been for the good. In just the past week, investors were treated to the news that not only had the U.S. economy rebounded sharply (4%) according to the preliminary Q2 GDP estimate, the 2.9% dip registered in Q1 was revised to indicate a 2.1% decline.

Friday's jobs numbers for July, while less than the blockbuster showings seen in recent months, also provide evidence of a continuing recovery.  Nonfarm payrolls added a lower-than-expected 209,000 jobs in July, after adding an upwardly revised 298,000 (from 288,000) in June. But the sectoral distribution of these gains indicates a healthy mix, with goods-producing jobs up 58,000 and manufacturing jobs up 28,000 and construction up 22,000. Significantly, temp employment growth slowed and, as opposed to June, most of the newly hired landed full-time jobs. Also, the labor force increased by 329,000 last month, causing the unemployment rate to tick up to 6.2% and indicating that some discouraged workers are again looking for work

Earnings have (so far) come in nicely, with a greater percentage of S&P 500 companies beating Street estimates than is normally the case.

So What's the Deal?

The market for everything from penny stocks to blue chips laid an egg last week in large part because of an even higher-than-usual sensitivity to the effect of rising economic indicators on U.S. Federal Reserve intentions going forward. While it is already a given that new purchases under the quantitative easing program will end by October, the concern is that the latest round of good news will prompt the Fed to raise its near-zero short-term interest rate targets sooner rather than later.

The bears would have a persuasive argument if the economy were demonstrably overheating and the stock market grossly overvalued. For the time being, neither appears to be the case.

Friday's less-than-overwhelming jobs report is a case in point. Not only did jobs growth slow down in July, hourly earnings flatlined after inching up 0.2% in June.

Even the "blockbuster" GDP advance leaves something to be desired, if you drill down. Real final sales, which fell 1% in Q1, managed to score a 2.3% gain. While this is nothing to sneeze at, it is well below the pace set in the second half of last year and effectively demolishes upside predictions made at that time.

At the same time, the stock market, while trading at high levels, is nowhere near "irrational exuberance." The S&P 500 is currently trading at about 18x earnings, which is hardly unreasonable, particularly when you consider the continuing stimulation coming from the Fed.

It also may be easier said than done for the Fed to rein in growth when it decides to do so. Considerable discussion at the central bank has centered on the tools that may be eventually employed to raise short-term rates. At the same time, with the Fed continuing to retain the trillions of dollars worth of assets it has acquired (while reinvesting the principal) in its apparently successful attempt to pump up the economy, long-term rates are probably going to stay low for a long time.

We may be missing something here, but the balance of evidence points to the last day of July as an opportunity for bargain hunters. Assuming there is nothing more ominous at work than the usual Fed policy jitters, there is a better-than-even chance that stocks will rebound after hitting bottom. See you in September!