Investors Take Warning: Storm Clouds Gathering

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As parties go, this one’s been raging for quite a while. After dipping below 6,600 just two short years ago, the Dow Jones Industrial Average has now nearly doubled.

If you were fortunate enough to invest in stocks near the market bottom – and if you bought the right stocks – you’ve made a killing. (Take a look at my personal portfolio and you’ll see what I mean.)

But that’s history. If you don’t own stocks, stock mutual funds, or ETFs, is now the time to buy? And if you were lucky (or smart) enough to pull the trigger back in 2009, is it time to sell and protect your profits and/or your principal?

The answer to both questions is no. Back on March 11, in this Ask Stacy column, I said the market wasn’t looking good and that I’d be reluctant to buy in the immediate future. But I also believe that the economy will continue to recover, so there’s no reason to bail either. In short, this is one of those times when the long-term investor adjusts their expectations – but not their portfolio.

Trouble ahead?

When I say adjust your expectations, what I mean is brace for some short-term bruising. Here are a few economic headwinds around these days…

  • The end of QE2: The government’s second program to keep interest rates low – known as quantitative easing, or QE – is set to end in June. This program, through which the Federal Reserve has been buying about $75 billion in treasury bonds weekly, is designed to keep interest rates low. When the buying stops, some say rates could rise and stocks could fall. Here’s an article from U.S. News & World Report with more details.
  • Job growth is slowing: After last week’s announcement that only 54,000 jobs were created in May, economists are fretting that consumer spending will slow. Since consumer spending makes up 70 percent of the U.S. economy, that’s a potential drag on stocks.
  • Political wrangling over the debt ceiling. As I wrote a couple of weeks ago, our nation is now bumping up against its credit limits. Some think refusing to increase the government’s ability to borrow isn’t that big a deal, while others think failing to raise the debt ceiling would be catastrophic. But one thing’s for sure: Stocks won’t respond well if the government is unable to meet all of its obligations when the limit is reached on August 2.
  • High gas prices: Money you spend on gas helps the Middle East and big oil companies but doesn’t help the American economy.
  • Housing prices: Home prices nationwide are now at their lowest since 2002. According to this AP article, homeowners have now lost more equity than during the Great Depression of the 1930s – back then, it took 19 years for prices to recover. If folks are afraid to buy or can’t sell, that’s another drag on the economy.
  • The European debt crisis: It may not seem that Greece’s problems could affect us, but with the increasingly global economy, when Europe sneezes, U.S. markets could catch a cold. Recently, Standard & Poor’s cut Greek government debt to junk status, and stocks worldwide took a hit.
  • Emerging market slowdown: While our economy has been sputtering, emerging economies in Asia and elsewhere – most notably, China – have been going gangbusters. But the Chinese government recently raised interest rates and took other measures to keep their economy from overheating – a negative for the many U.S. companies that do business there. According to this recent CNN/Money article, “It goes without saying that a healthy Chinese economy is key to keeping the U.S. and global recovery on track.”

Those are some of the problems that stocks are currently facing, and they’re reason enough to be concerned about the short-term. But as I said earlier, while these concerns are enough to keep me on the sidelines, they’re not enough to chase me out of the stock market. Why haven’t I sold a single share?

The good stuff

  • Interest rates are still low: Although the Fed’s QE2 program will end soon, the Fed has signaled they’re not concerned about inflation and will keep interest rates low until they’re sure the economy is growing again. Low interest rates are good for stocks.
  • The economy is still growing: While only 54,000 jobs were added during May – a number far below estimates – jobs were still added and the economy is still growing. An economy that’s growing at a snail’s pace isn’t the same as one that’s shrinking. In a speech this week, Federal Reserve Chairman Ben Bernanke said, “The economic recovery appears to be continuing at a moderate pace, albeit at a rate that is both uneven across sectors and frustratingly slow from the perspective of millions of unemployed.”
  • Gas prices are coming down: At a national average of $3.76/gallon, prices are already down from a few weeks ago. From this May 7 AP article: “It’s going to be $3.50 per gallon this summer,” oil analyst Andrew Lipow said. “At the very least, you can expect prices to fall 40 cents or so over the next several months.”
  • Emerging markets are still growing: As I mentioned above, China is putting the brakes on its economy. But China’s economy is still expected to grow close to 10 percent this year. That’s a huge number.
  • The debt crisis will be dealt with: While politicians may take it down to the wire, they’ll probably approve an increase in our nation’s debt ceiling. And while the process of dealing with our massive budget deficit won’t be pretty, it’s a lot better for the country and the stock market than ignoring it.

In a January story called 3 Places to Put Money Now, I suggested putting money into stocks, real estate, and paying off debt. While paying off debt is always a great place to put money, my assumption regarding real estate was almost certainly too optimistic – at this point it looks highly improbable that housing prices will begin any sort of a turnaround this year. As for stocks, while the jury is still out, I’m concerned: I wasn’t expecting this degree of slowdown. But I’m still not throwing in the towel – yet.

Bottom line? Expect tough sailing in the immediate future and keep your eye on the news. If our economic recovery continues to falter, that’s going to be reflected as lower stock prices. Long-term, however, I’m still looking for stocks to do well. So if you’re putting money monthly into stock mutual funds at work or elsewhere, don’t stop. But don’t expect any easy money for the next few months.

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