Last week marked a major milestone: The economy grew at a stronger-than-expected 3.5% pace in the third quarter, strongly suggesting that the so-called Great Recession ended sometime this past summer. It officially began in December 2007 and, if it indeed lasted until July, that means it survived all of 19 months.
This should not have been all that surprising to followers of the stock market. The rule of thumb is that market averages anticipate the real economy by six months. Since the averages bottomed on March 9, the recession should have ended six months later, on Sept. 9. The market may have been a little slow to predict a recovery, but it nonetheless did a pretty good job of forecasting an economic rebound at a time when many remained deeply pessimistic.
Still, I don’t recall anyone celebrating this past summer. I did a pretty good job at calling the start of the recession in 2007, but its end went unrecognized by me. Indeed, this summer the stock market was in the midst of a modest correction that ended in mid July.
Despite the growth in GDP, the recession still doesn’t feel like it’s over, especially given the continuing rise in unemployment, a so-called lagging indicator, and thus one of the last to show improvement. Most people I know are still worried about their jobs, curbing their spending, and worrying about their home values. But if the economists (and the stock market) are right, we should all start feeling better in a few months.
The ongoing skepticism about the recovery and accompanying rise in the stock market may be the strongest factor fueling further market gains. That’s because classic market tops are accompanied by buyer capitulation, when the last skeptics throw in the towel and buy. That leaves a preponderance of sellers, and stock prices sink. I don’t put much stock in the search for such technical indicators as “buying climaxes,” but there are still plenty of skeptics out there. The cover headline of Barron’s this week was “Watch Out!” -- which echoes what I’ve been saying for weeks.
Though the market averages have pulled back modestly from their mid-October highs, there’s recently been a tug-of-war between buyers and sellers, with a recent sharp rise in volatility. This week the VIX, the standard measure of volatility, reached 30, the highest it’s been since July. Considering it was at a record 80 just a year ago, this seems pretty tame, but its rise also suggests there’s a good deal of uncertainty among investors about where the market is headed. That, too, may be a bullish signal.
An elevated VIX usually means that options premiums are also higher. That means it’s a good time to be a seller, either of calls on existing stock positions (covered calls), or puts. Last year, with the VIX at extremely elevated levels, I sold puts on a variety of financial stocks to take advantage of the rich premiums. (See “Put Premiums Are Too Rich to Pass Up.”) A put is an option to sell; selling a put means you agree to buy shares at the strike price. The risk is that the shares are far lower than the strike price when the put option expires, and you have to buy the shares at the higher price. There’s little danger of this in my case, barring a financial catastrophe in the next few months. I sold put options on JPMorgan Chase, Morgan Stanley, and PNC Financial which will expire in January. The shares have risen so much that these puts are trading for pennies.
I sell puts when I expect stocks to rise further. With financial stocks already having risen so much this year, I wouldn’t try to replicate the strategy now. On the contrary, I’d sell calls, a strategy I’ve recommended after big gains. (See “Trading Strategies for an Uncertain Market.”)
Then again, you don’t have to sell (or buy) anything. Sometimes I’m quite content to be an observer, and now is one of those times. If you’ve been following my recent advice and have taken some profits, you’re well positioned whether stocks rise or fall.
While speaking of milestones, congratulations to Chief Executive Alan Mulally and everyone at Ford (F) for the nearly $1 billion in third-quarter profit the company reported this week. This is even better than I expected, and I’ve been bullish on Ford and own shares. (See “Buy American? The Case for Owning Ford.”) Even more impressive was Ford’s rankings in last week’s annual Consumer Reports auto survey. The magazine hailed Ford’s “world-class reliability,” and the Ford Fusion and Mercury Milan outranked the best-selling Toyota Camry and Honda Accord. As I’ve said before, it’s all about the cars — the profits will follow.
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