Great Expectations

In the Dickens novel “Great Expectations”, the main character Pip, a young working class orphan, inherits a fortune from an unknown benefactor and becomes instantly rich. He abandons all he knows, embraces his “great expectations” and pursues the life he has always aspired to. However, this sudden unforeseen success is muted due to subconscious feelings that he is unworthy of his good fortune and sadness and heartache ensues. In the recent market rally with the S&P 500 raising as much as 16% from its low in July, one would think investors would become more optimistic about the economy. Conversely, a recent poll found that just 37% of the public believes that the economy will improve in the next year — this down five points from a year ago. Those following technical analysis also have reason for “great expectations” as the SP 500 50-day moving average crosses above the 200 day moving mark, indicating the short term positive direction of the market is likely to continue. Additionally, the market historians have reason to be optimistic whereas for the past sixty years, the markets have typically performed tremendously well during midterm elections — averaging double digit returns consistently with only a few down years. In my last post, I discussed “embracing the stalemate” referencing the potential stalemate in the government which historically has proven to be the best possible environment for stocks. Even those that rely on corporate fundamentals have a reason for “great expectations” considering 85% of the 132 companies in the S&P 500 that reported earnings since October 7 have topped analyst per-share earnings estimates.

So why do so many of us share the dampened spirits of the young man in the novel “Great Expectations”? Perhaps because we feel that somehow the recent gains are not truly deserved and the potential for losing them looms large. The focus of the meeting of finance ministers and central bankers in the G 20 this weekend was to address the growing problem of countries relying on weaker exchange rates to spur economic growth. The ironyof the meeting centered around Timothy Geitner “expecting” China to allow the Yuan to strengthen in the interest of domestic growth and global economic stability. Geitner failed to mentionthe fact that the dollar is at a 15 year low due to the excess and potential future use of quantitative easing but did say for the first time, that it’s in the best interest of the United States that we have a strong dollar. If we are to have a strong dollar the quantitative easing estimated to begin in early November and projected to amount to over 1.4 trillion dollars (with recent predictions by Goldman Sachs analysts of 2 trillion) needs to be curtailed significantly. The overall rationale responsible for much of the advance of the market has been QE and, in the likely event that it is reduced or eliminated, the effect on the market will be negative — if in fact it was the main reason for the market advance. The Chinese will make small symbolic gestures to give the illusion that they are not manipulating their currency resulting in devaluation of the weaker currencies and worldwide inflation. Anyone disbelieving that cheaper currency is not a concern for weaker economies, should consider the tax Brazil imposed on foreign capital as a way to protect their currency and reduce the potential impact of inflation.

This rally will continue to run as long as the government pumps money into the economy; however, when it stopswe will need to prepare for a pull back. In the verbiage of Timothy Geitner, although not yet repeated by Ben Bernanke, that we are given the hint that QE may end sooner than we think, the central bank and Geitner face an insurmountable challenge. It’s impossible to strengthen the dollar and head off inflation without ending QE. If they end QE, they risk the stock market falling and the economy slowing further. The decision they need to make — whether to artificially pump up the economy or let the free market prevail and find other ways to stimulate growth — such as tax cuts. If they continue to artificially inflate the economy, they will cause worldwide rampant inflation which could find its way into our economy sooner than we think. We are continuing to trade this market short term, utilizing tight stops on our long positions — buying commodities, precious metals, base metals, mining stocks and using inverse ETFs to short the US treasury in anticipation of bond prices falling. We also feel that the Euro is overvalued and we expect a pullback.

Many people consider the novel “Great Expectations” a tragedy insomuch as the young man loses everything he has — counting too much on what he does not already have and valuing too little of that which he does have. However, it was in the lessons he learned and the love he attained which brought him true happiness in the end. In our “great expectations” that we have for the future of our nation and our personal economic life, we should always remember — we don’t need to lose everything to achieve the success we desire, if we  pursue our goals with unrelenting discipline and diligence. In a quote by Dickens himself he proclaims that, “there is nothing so strong or safe in an emergency than the simple truth”.

Thank You,
Jeffrey C. Sica
President
Sica Wealth Management, LLC