While the debate over the length and severity of the recession continues to play out in the media, most thoughtful and credible economists are calling for positive economic growth by the third quarter of this year. The second quarter (just passed) is likely to show negative growth, but a smaller decline than that of the first quarter. The consensus is suggesting that GDP growth in 2010 could be around 3%. Although I would be the first one to suggest that the correlation between the overall economy and the stock market is less than perfect, rising GDP does imply rising corporate earnings, which is a key driver of the stock market. I find it hard to believe that the stock market would go down in the face of a steadily improving economy (something suggested by the consensus economic forecasts). Thus, I would not be surprised to see higher stock prices into 2010.
Another way to look at the current situation may be to recall the stock market’s action in 2003. By early 2003, the bear market was over 2 years old, and large numbers of widely-held stocks were down 50% or more. The economy had also been struggling for a few years, following the tech bubble of the late 1990s. Global tensions were high in the wake of 9/11, and ironically the stock market bottomed in early March, the day US troops invaded Iraq. The market rallied well from there, but by July many were suggesting the market had run out of steam. Because early signs of improvement were just starting to emerge, many suggested to “buy on weakness.” The market never really corrected, but did flatten out for a few months. The rally resumed by autumn and the stock market return for 2003 came in at +28% or so, the best year in a long time.
Every market and cycle is different, but I see important parallels here. This year the market bottomed in the middle of nothing but bad news. As it rallied, many were calling for caution. Now, many are calling for a pull back, something that would allow investors to buy stocks at better prices. And the consensus outlook is for an improving economy. I do not make forecasts, but I we would not be surprised if the market does not pull back as expected. As so often happens in the early stages of a market recovery, those looking to buy at lower prices may be disappointed. Concern and skepticism about the market right now are two factors that could help propel it higher to the end of the year.