Long Term ‘Ostamisty’….

Anyone remember Sammy Sosa, the larger-than-life (because of steroids?) outfielder for the Chicago Cubs? Sammy used to say that “baseball has been berry, berry good to me” and that he was “ostamisty” about the Cub’s chances every spring. The stock market has also been flashing ‘ostamisty’ signs as investors have been pouring money into stocks and out of bonds in a search for yield since the Fed is keeping interest rates near zero percent. This Fed inaction may once again lead to a market calamity and send the investor sheep over the cliff. Our GDP stands at roughly 14.7 trillion dollars and the market capitalizations of the New York Stock Exchange and the NASDAQ were 13.3 trillion and 3.9 trillion as of December, respectively. This means the market cap is roughly 117% of the GDP. The average since the 1920’s has been 62.4%. Now, with the outlook for growth in GDP a not so robust 1% to 2% for 2011, depending on who you listen to, how can the market sustain a rally? Either the GDP has to increase significantly or the market cap has to decrease to bring us back towards the long term average of this ratio. Right now, the ratio suggests that we have a ceiling on the market at roughly Dow 14,500 (a gain of 18% from here) with a bottom needed to bring us back in line with the average at roughly Dow 5000 to 6000. That is to say, we are in a trading range right now at levels suggesting great optimism for the US and world economies. Of course, these analyses always look dire when coming out of a recession, let alone a market meltdown. The major point here is that it may be tough for the stock market to muster outsized gains anytime soon and will probably trade in a range for a few years to come while we wait for our economic engine to get back into high gear.

But, this is all just technical analysis, of course, and ratios can get stretched much, much more than what we would think is possible. The problem for me right now is the fundamentals. Yes, the US economy is growing and, yes, we are out of a recession, but why is it reported, then, that the bulk of small business owners feel pinched and will have to rely on personal savings to stay in business in 2011? With consumers not spending as before the recession (notice the new surge of savings and frugality spreading?) and gas prices threatening $4.50 a gallon, it may be tough to generate the needed corporate profits to advance stock prices. What will happen come June when the government’s QE2, or quantitative easing II, program of bond buying expires and the markets lose that stimulus safety net? Lastly, when the Fed does finally act and raise rates, what will happen to stock buyers? Will they lose their intestinal fortitude and rush back to cash?

Market cycles tend to take many years to ‘digest’ gains after a big rally…sometimes 25 years or more. We are currently about 11 years into a digestion cycle following the big run-up between 1982 and 2000 beginning with the bursting of the internet bubble. I suspect there may be more digestion ahead. It is going to take a new administration, a new feeling of hope and a pro-business agenda to kick start the next market run. It’s not any one President’s fault that the stock market fluctuates… sometime the economic cycles just gets in the way.

I am long term optimistic, or ‘ostamisty’, about both the Cub’s chances (sometimes it takes 100 years or so to digest gains in baseball!) and the stock market and am not abandoning either here as I believe it is not possible to time the changes with accuracy. I would like to have some cash liquid, however, to be able to buy into opportunities when they present themselves.