Pennsylvania Investment Observer

Wither, the Stock Market?

by Daniel J. Nestlerode

With the first quarter of 2004 now in the bag, how is the stock market doing? The answer is so-so. Well then, how is the economy doing? And the answer is very well, thank you! How can the economy do well and the stock market perform in a so-so fashion? That is the $64 question. Why a $64 question? I don't know.

Measuring the performance of the stock market is fairly easy. By default, most investors select one or more stock market indexes or averages. On our daily market commentary, available on the web at www.nestlerode.com, we report on the change in the Dow Jones Industrial Average, the NASDAQ average and the Value Line Geometric Average of Stock Prices as well as provide a brief commentary about the events on Wall Street. Although each average measures something a little different about the stock market, one can generally assume that the movement of the averages will reflect the market accurately enough to give one a sense of the direction of all stock prices. In the first quarter, the Dow was down about one percent, the NASDAQ was down just a half of one percent and the Value Line Geometric Average of Stock Prices was up 4.2%. The broader based Value Line Average is telling us that small capitalization stocks performed better than the bigger capitalized well-known companies in the first quarter. So far this month, the Value Line Average hasn't moved, while the Dow is up about eight tenths of one percent and the NASDAQ is one percent. Perhaps, the large capitalization companies are starting to perform better, at least as measured against the small cap. companies. Still, the stock market seems to be stuck in neutral while the economy seems to be getting a lot better. Shouldn't the performance of the stock market mirror what is happening in the economy?

The economy is moving into the second quarter and companies are just beginning to report the results for the first quarter. It takes a few weeks to get the data together. According to Zacks, a well-know investment advisor, it appears that earnings are likely to grow at an annual rate of 15% in the first quarter and the GDP is likely to leap about 5%. Even employment is finally beginning to gain some traction in the recovery of the economy. All other things being equal, you might expect the stock market to rise about 15% in line with the earning's increase. Yet, so far, the stock market is stuck in neutral while the economy surges ahead. Why?

The reasons "why" something happens are different for the "thing" itself. Explanations lie in the domain of explanations or reasons while events lie in the domain of events. Sometimes the explanations make sense and are understandable. Sometimes the explanations illuminate what might happen in the future. Sometimes explanations are just stories that we understand and with which we agree, having the same biases as the storyteller. So for those of you who have to put a reason, explanation or story attached to what the economy and stock market are doing, here are several reasons de jour. Pick the one you like the best and spread it around to your friends and associates. Then watch how the stock market unfolds in the months ahead.

1. The stock market doesn't like uncertainty. With the war in Iraq not going well, investors are nervous and unwilling to buy stocks until Iraq is no longer a daily news item.
2. The stock market doesn't like uncertainty. With Kerry running 46% of the electorate and Bush at 45%, with a 2% error factor in the survey, we aren't sure who is going to be president and so we aren't sure about economic policy as the current tax breaks expire. So why buy stocks now, when the tax rates might be higher if Kerry wins?
3. The stock market anticipates the future of the economy, rather than reflecting the current results. Perhaps the stock market foresees problems in the economy coming later this year or early next year.
4. We now live in a world where terrorists can strike at will. With this uncertainty, stock prices should just be lower in general. After we catch Osama bin Laden and the rest of his crew, then stock prices will rise.
5. Interest rates are probably going to rise in the coming months, so why buy stocks if interest rates might offer better returns later this year. Besides, don't stock prices do poorly when interest rates are rising?
6. The stock market always does better when the Democrats are in White House. The market will do better when and if Kerry wins in November. So investors are waiting to see the presidential outcome in November. (Considering the last presidential election, perhaps I should say: hopefully in November.)
7. None of the above. Make up your own explanation.

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