Three down days for equities, combined with some mildly disappointing reports on durable goods and home sales, have raised concerns that the stock market may be at the start of a correction. Such a retreat seems entirely reasonable following a huge 58% rise in the S&P500 from March 9th to September 22nd. However, provided the economy continues on a path from recession to recovery, long-term investors would likely be better served by a long-term bet on economic expansion than trying to time corrections on what should still be a rising stock market path.
Economic numbers coming out this week should be reassuring on the issue of the recovery.
Consumer confidence, due out on Tuesday, should rise in line with gains seen in other consumer surveys, while both the Chicago and national purchasing managers’ surveys should show continued improvement in manufacturing.
Even lower-than-expected inventories in June should prompt a downward revision to second quarter GDP, increasing the peak-to-trough output decline in the recession to an even 4.0%. Vehicle sales likely fell heavily in September from August due to the end of the “cash-for-clunkers” program, and the pending home sales index may have slipped back following strong gains in recent months. However, over the next year, inventories, auto sales and housing starts should all resume a path back to normal levels which will be a powerful source of economic growth.
Finally, the unemployment claims data, due out on Thursday and the September jobs report due out on Friday should confirm that the pace of job loss is continuing to ease.
The impact of a turn in the economy should be evident in earnings reports over the next few weeks. In the second quarter, positive earnings surprises outpaced negative surprises by more than a 3 to 1 margin and with earnings estimates rising strongly going into the earnings season, S&P500 firms ought to be able to beat the roughly $14.50 expectation for 3Q earnings. Indeed, the next few quarters should see very positive earnings trends given low wage and interest costs and improving revenues.
A steady trend of improvement, however, should be more ominous for Treasuries, as super low real yields (such as 1.6% on a 10-year TIP) seem out of whack given the prospect of an improving economy and ballooning government debt.
Technically, the stock market may be overdue for a correction and there are plenty of domestic and geopolitical issues which could trigger one. However, for investors, the prudent course is probably to regard continued recovery as the most likely scenario and invest in a way to take advantage of it.
David Kelly is chief market strategist for J.P. Morgan Funds.