Research & Insights

Midweek Market Comment: A Slow-Burning Funk

June 9, 2011

By Katrina Lamb, CFA

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Some market corrections are like sudden hysterical meltdowns – dramatic and immediate. They erupt and send everyone to man the panic stations – and then just like that they are over. Investors come wading back in to snap up bargains and the world moves on. Most of the market corrections during the Great Bull Market of 1982 – 2000 were of this variety, most notably the short-lived freefall of Black Monday in 1987.

Other times, though, bear witness to a different kind of correction, and right now we are in one of those times. This is more like a slow-burning funk than a dramatic meltdown. The S&P 500 reached its 2011 high point (to date) back at the end of April. Since then the index, and most other equities indexes, have been stewing in a six week funk. The stock market’s losses have been the bond market’s gains – the Russell 3000 ended June 7 up 3.3% for the year to date, and the Barclays US Aggregate Bond index closed at 3.2% for the same day – virtual parity.

It is worth recalling that this pattern is not entirely different from one year ago, indeed for some of the same reasons. Then, as now, concerns about Greece and other Eurozone tinderboxes were spooking risk asset markets. The global economy was trying to find its footing and getting there in fits and starts. Summer usually means lighter trading volumes than usual, so price trends tend to be accentuated. But there was one significant difference. Last summer the Fed announced its intention to embark on a new plan of monetary stimulus in the form of quantitative easing – QE2. That announcement sparked a rally that took equities and other risk assets sharply higher through the end of 2010 and into this year. Now, QE2 is coming to an end this month. In a press conference on June 7 Fed Chairman Bernanke appeared to stick to the Fed’s position that there will not be a QE3. Markets promptly resumed the slow-burning funk after being comfortably higher for most of the trading day.

The easy answer to formulate from this is that investors lack the confidence to flip the “Risk On” switch without regular fixes from the Fed’s store of steroid juices. There is no doubt some truth to that, but in our opinion that is not the important story. Indeed, the expectation going into yesterday’s Fed conference was that there was no QE3 plan anywhere visible to the naked eye. If Bernanke had suddenly announced a plan it would almost surely have turbo-charged the markets for a day or so, but it would also have meant that the Fed took another look at overall conditions and came to the conclusion that the economy was still unable to stand on its own two feet. Euphoria would have quickly ceded to sobriety and fears that things were much worse than they appear. Analysts would start revising their earnings expectations downwards and market valuations would follow as surely as night follows day.

So here we are with the training wheels off, taking the first hesitant pedals without Uncle Ben keeping the bike steady. If we can keep from falling over in these first few moments, that could be a sign of a more tractable and sustainable underlying strength that could in turn pull risk assets out of their funk.


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