“You put your left leg in, and you shake it all about,
You do the hokey pokey and your turn yourself around.”
- lyrics from a popular participation dance

One step forward, one step back, the stock market is acting like the
hokey pokey so far in 2010. With lots of movement but not much change,
U.S. equity prices are virtually where they started the year. The Dow
Jones Industrials is -2.8% since January 1, while NASDAQ is -0.5%.

For the month of May, the Dow lost 7.9%, its worst showing since 1962.   Fifty-two years ago, in the second year of another young Democrat President, the economy was sturdy and interest rates were low.  But investors fear that President Kennedy’s attacks on business, particularly the steel companies, would jeopardize the good times.  A stock market correction began on April 23, 1962 and the Dow dropped 17% by late May.  But from that low point in May, the Industrial Average advanced 17.9% by December 31.  Will history repeat?

We won’t know the answer to that question for another seven months.  But we do know that setbacks like we’ve just experienced happen in the market quite regularly.  Barron’s magazine http://www.online.barrons.com this week reports that corrections tend to occur in the second year of nearly every bull market and have averaged -12% since the 1940s.  Corrections are a normal process to higher prices.

Nevertheless, many investors fear that this correction could be the start of another bear market.  Confidence is very fragile now; faith in markets is frail.  Lots of people were devastated the the unbelievable sequence of events that led to the Great Recession and the Great Bear Market.  Few have forgotten late 2008 and early 2009.  The unimaginable happened.  And a lot of people still believe the improbable can happen again.  Investors are huddled the exits of the Wall Street theatre, waiting for any sign of smoke or file so they can sell.

A recent survey shows that the majority of investors are bearish, dwarfing the bulls by the biggest margin in a year.  Professional money managers are buying portfolio insurance recently at the same levels as the 1987 Crash, the 1998 Russian default, the dot-com bubble, 9-11 and the 2008 Lehman downfall.  Should they be so worried?

While much remains unclear about the economic and political outlook, ambiguity is with us always.  The world is certainly in much better shape than two years ago when talk of Great Depression II was common.  In China, economic growth accelerated to 11.9% in the first quarter from 10.7% in the fourth.  Even Japan’s mature economy is getting a sharp lift, primarily from exports to their rapidly growing Asian neighbors and rising consumer spending.  Japan’s first quarter GDP was +4.9% versus 4.2% in the fourth quarter.  First quarter GDP grwoth for the United States was +3%.

Sure, the European debt crisis causes insecurity, even fear, as we hear the news, but this sort of thing has happened many times in the past.  Greece first issued debt in 1824 and paid just five interest payments before defaulting in 1827.  National defaults in Europe are infrequent, but are not unheard of.  Austria has defaulted three times, Bulgaria twice, Germany once in 1932, Hungary in 1932, Italy, 1940, Poland twice, Portugal twice, Romania three times, Russia twice, Serbia/Yugoslavia three times, Spain three times, and Turkey fourt times.  There were temporary dislocations when these defaults occurred, of course, the world soon went on about its business and stock prices eventually moved higher.  They always do.

The U.S. economy is recovering well.  Corporate profits have had a V-shaped rebound.  The consensus earnings forecast for the S&P 500 rose to $82.11 in May up from $78.91 in April.  The 2011 forecast was bumped from $95 in April to $96.65 in May.  Stocks are cheap.  The forward P/E is 12, the norm is 15.  By comparison, cash offers very skimpy yields.  The upset over the Great Bear Market will steadily diminish and investors will sooner or later return to investing in stocks again.

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About Richard Leader

Richard Leader is President and Chief Investment Officer of First Houston Capital, and has more than 30 years of experience making solid investments for clients. He is actively involved in all aspects of stock selection and portfolio design for clients of the firm. Richard began his career in 1976 with Citibank’s Investment Management Group in New York City. He was transferred to Houston in 1980, and through a succession of increasingly responsible positions, Richard has developed a thorough knowledge of economics, securities analysis and portfolio management. Richard received his undergraduate degree from Wake Forest University, followed by an MBA from Vanderbilt University. He also earned his Chartered Financial Analyst (CFA) in 1981 following a three-year program of study and testing.Richard, his wife Carrie Leader and their four children are active in St. Luke’s United Methodist Church, Memorial West Swim Club, BraeBurn Country Club and the Houston Safari Club. Richard has also been on the Board of the Woodland Hollow Civic Association and is currently the President of the Wake Forest Alumni Association/Houston Chapter.Each week, Richard provides his perspective on the financial markets and the economy in his Leader Market Letter and on the firm’s Leader Market Letter blog.

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