Economy, Market Signals Mixed


The Forecasts has long advocated a multifaceted approach to investing.

We consider the Dow Theory, valuations, profit prospects, and economic trends to discern the health and strength of the market. However, the picture gets more complicated when the economy can’t make up its mind. For now, we’re content to keep playing some defense, holding 20% to 25% of equity portfolios in a short-term bond fund.

Pros and cons

Pundits looking to predict the market’s future can find plenty of support for both sides of the argument. Bears will appreciate these three tidbits:

The housing market continues to disappoint, with sales of both new and existing homes falling in January despite expectations for modest increases.

Initial claims for unemployment rose to 496,000 last week, up 15% from levels at the start of the year.

The University of Michigan and Conference Board consumer-confidence indexes fell more than expected in February.

Bulls, on the other hand, are more likely to cite:

The Commerce Department revised its estimate for December-quarter gross domestic product, now pegging growth at 5.9%.

In February, the Chicago Purchasing Managers Index rose for the fifth consecutive month, suggesting that the manufacturing sector is gaining strength.

The Dow Industrials have rallied to within 3.2% of the January high, while the Transports have bounced back to within 2.8%.

Back to basics

Given the economy’s mixed signals, it becomes doubly important to let the stock market tell its own story. The Dow Industrials are up 62% from the March 2009 low, while the Transports have jumped 96%. Those gains could still prove to be the mother of all bear-market rallies, but that is just one possibility.

Another possibility is that the rally represented the first leg of a new bull market. In that case, we’re still awaiting the significant correction, followed by higher highs, that confirms the bull signal. Alternatively, we may have erred in labeling the May and June market pullback as insignificant. So, while a near-term move above the January highs would bode well for near-term market action and prompt some increase in our stock-market exposure, we’re not convinced such a move would represent a bull-market confirmation.

In the wake of such uncertainty, holding 20% to 25% of equity portfolios in short-term bonds seems prudent.

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