Will there be another dip in US stocks?

Thursday September 17, 2009
Will there be another dip in US stocks?



ON the first anniversary of the Lehman Panic, investors may not have noticed that the New York Stock Exchange (NYSE) has already been rallying for six months and has risen a hefty 56% and yet there are many out there looking for the other shoe, the second dip, the W, and so on.

Looking at the persistently high cash level of the institutional fund managers, there is no doubt that there are many, many investors left out in the cold in the current rally. Many of them may end up holding cash for a long time that pays no or little interest. Why?

With the NYSE up 56%, these institutional lemmings are scared stiff to buy now because they think the NYSE will make another major drop. So, it is better to wait for the double dip or the W or whatever Armageddon to happen first.

Then, when the economic data come out showing that the US economy is on a decisive recovery path, one would have thought that this would be convincing enough for them to invest. Apparently not, as they also get scared stiff by this. Why?


The other worry that many investors have is that the US economy will be hit by high inflation as the economic recovery takes hold. The reasoning is simple. The US economy has been boosted by a massive injection of monetary and fiscal stimuli. These can only lead to rapid economic growth, and thus higher inflation.

As this happens, US interest rates are going to surge and this will take the US economy and NYSE down. So even the reassuring economic numbers are spooking these lemmings instead of reassuring them. Such a phenomenon is a simple reflection of how frightened investors have become. Nothing can be right. More importantly, are the concerns over rising inflation justified?

i Capital is of the view that the concerns of high and rising inflation happening in the next two to three years are misplaced. There is no doubt that the monetary and fiscal injections have been large but the global panic was of a massive scale. Without a sufficiently large stimulus, investors would not have been reassured and the panic would have ensued.

Then, there is plenty of spare capacity in the goods and labour markets. Factories have enough capacity to meet consumer demand without having to hike product prices and the labour market has enough workers to meet the demand of employers without having to pay higher wages.

Globally, the same situation applies. At the same time, there is no fear of a sustained deflation.

Producers face rising commodity prices as demand from the rest of the world, led by China, stays healthy.

While companies cannot raise selling prices, they cannot lower them by much or for a prolonged period either. In the end, the outlook for the US pricing environment over the next two to three years is rather sanguine.

Showing the headline and core inflation rates since 2002, the chart captures the sanguine scenario best.

The spike in US inflation rate in the second half of 2007 and the first half of 2008 was due mainly to the surging energy prices and then the inflation rate slumped in second half of 2008 and first half of 2009, again due primarily to the plunge in energy prices.

We all know that energy prices have been extremely volatile. So, policymakers tend to watch the core inflation rate, which has been remarkably stable at 1.5% to 3% in the last six to seven years, even when the US economy was booming.

i Capital is of the view that the lemmings waiting on the sidelines with their piles of cash would have a long time to wait.

The NYSE is not going to crash in September and October 2009 and inflation is not going to rear its ugly head anytime soon. i Capital sees the NYSE pausing further as it navigates these two months.