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A new season, a new reason to doubt the bulls

Happy Gann Day to you and your portfolio. This is the date – Sept. 22 – that W.D. Gann, a financial speculator of a century ago, pegged as the most dangerous day in the calendar for investors. For some reason, financial crises tend to cluster around the autumn equinox.

This year, of course, there's absolutely no sign of imminent danger. (Just ask your broker.) The S&P 500 is trading near its highest levels since 2007 – a bullish sign for the economy, since the stock market has traditionally been a leading indicator of business conditions ahead.

But in honour of Mr. Gann, let's take a walk on the wild side and ask whether the stock market could conceivably be more vulnerable than most people think.

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The biggest reason to doubt the market's advance over the past year is the lack of any corresponding improvement in the real world. While stocks may be back to 2007 levels, the U.S. economy isn't. Unemployment remains stubbornly high, many retailers are struggling and manufacturers are finding it increasingly tough to land new orders.

Barry Knapp, head of equity strategy at Barclays PLC's U.S. securities unit, has produced a chart showing the growing gap between U.S. stocks and the factory floor. While investors are bidding up share prices, the Institute for Supply Management's new orders index for U.S. manufacturing is falling faster than Mitt Romney's popularity.

If you trust the stock market to signal what's coming next, the discrepancy between stock prices and factory orders is a surefire sign that economic data will improve over the next few months. Cynics, though, may see it as demonstrating the degree to which stock prices have become detached from business reality.

What everyone can agree on is that to justify today's stock prices we need some big, positive economic news – and the most likely candidate to supply that news is the U.S. housing market. Commentators have greeted a recent rebound in housing starts with breathless excitement; many see it as the first step toward a full recovery in the battered sector.

A housing resurgence would be great news for the wider economy, because home building creates lots of jobs and related spending. At the moment, though, a housing-led recovery is more hope than reality. At the height of the housing bubble, the U.S. was building more than two million homes a year. As the accompanying chart shows, the number of construction starts plunged when the bubble popped. That little bulge to the right of the chart? That's what all the recent excitement is about.

Yes, home building may climb rapidly in the months ahead – but, unlike the stock market, the real world still has a long way to go before it will clamber back to its old glory. Ponder that this Gann Day.

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About the Author

Ian McGugan is a reporter with The Globe and Mail's Report on Business and has been writing about investing, economics and business for more than 20 years. He joined the Globe and Mail in 2010. He has been executive editor of Canadian Business magazine and founding editor of MoneySense magazine. More


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