Dear Reader,
The markets are up 15% over the past year... If you had asked me what markets should have done on Monday, after we learned Enemy Number One was killed in a compound in Pakistan, I would not have guessed that markets would have lost points yesterday.
But that's what happened.
All three major indexes finished lower on Monday, and gold and oil also dropped.
In fact, some experts are saying the drop in oil prices was what pulled down the markets on Monday.
But let's keep things in perspective. Oil prices dropped less than $1 a barrel. With gasoline prices at a national average of more than $3.95 per gallon, you'd think that a drop in oil prices would be welcomed by the market.
Energy stocks took much of the hit, which added to the drop in the market. And yet, there might be another reason why markets lost some ground on Monday.
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Refocused on the Economy
From the Associated Press:
Buffett doesn't expect the bin Laden news to affect business much.
"I don't think this is a big market factor," Buffett said on the Fox Business Network. "The American people feel wonderful today -- all of us -- but in terms of earning power of American business, I don't think that factor should change dramatically because of this."
That means the market has been moved by what's actually happening in our economy. The market has been ignoring the truth about the American economy for a long time. And now that focus has turned back to the details.
Earnings reports have come off well this first quarter, but higher costs will start to eat into corporate profits. The market rally is already running out of steam.
Indeed, some investors, who have been holding on to gains from the market rally, used the news of bin Laden's death as a reason to sell.
This could put more important economic reports back in the spotlight.
An Unstable Recovery
The manufacturing index fell in April. The index is still signaling growth... just not as much as in March.
The economy is recovering. We will see GDP growth this year. But the recovery is happening very slowly, and there are some really strong arguments that question the strength of this recovery.
We've made some of them here. Food prices are still sky-high. Energy prices, too, despite the drop in oil prices yesterday. Unemployment is still outrageous, and government debt is still climbing. The Federal Reserve is holding interest rates near zero for an unknown amount of time.
None of this is good for the long-term health of the U.S. economy.
The problem is, in my opinion, the markets have priced in a full-blown recovery. Bloomberg reports, "The S&P 500 Total Return Index, which measures the gauge's performance including reinvested dividends, rallied for an eighth straight month in April to match its longest streak of gains since 1995."
And analysts are still saying that the markets are not overvalued.
This may not even be true in comparison to the S&P 500's historic average. The index showed a valuation of 15.5 last week, but since 1870, the S&P 500 has had an average P/E ratio of 15.
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S&P Doubled Since 2009
Just look at this rebound from the 2008 financial crisis:
View larger chart
Since March 9, 2009, the S&P 500 has climbed more than 101%. Now, I thought the bottom back then was way overdone. A lot of good, solid companies suffered right along with the companies that brought the financial crisis down on us...
But this rebound is ridiculous without the support of strong economic data.
Are we making improvements? Yes. Official unemployment rates are back below 9%. We're seeing consumers creep back into malls. Manufacturing is still growing... This is all good news.
It's a real start. By the looks of this chart, though, we've already done the heavy lifting, and that is nowhere near the truth.
In the next nine to 12 months, we could see corporate profits start to decline as energy and food prices are passed on to consumers. As the Federal Reserve comes out of its debt-buying frenzy, it might have to confront higher inflation.
"Free money in the hands of very smart people for too long is likely to create something unpleasant," Jack Welch said in an appearance on CNBC on Monday.
We have certainly dug ourselves a deep hole, and eventually the Fed will have to raise rates.
An already shaky recovery might not be able to handle that kind of intervention.
We recommend all our readers have some sort of inflation hedge in their portfolio -- even at these expensive prices.
Happy investing,
Sara
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