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MONDAY MORNING: The two-handed investor takes a pass

That two-handed financial adviser is back. He’s been looking out at the final quarter of the year and…

That two-handed financial adviser is back.

He’s been looking out at the final quarter of the year and trying to determine if we will wind up with a positive total return for equities this year or whether we will break our nine-year string of positive returns and five-year string of double-digit returns. And he’s also been trying to peer into the new year.

What does the future hold for the market?

Should an investor cut back the equity allocation in anticipation of a decent interval of flat or even negative equity returns? Perhaps this is the beginning of the long-expected and often-predicted reversion to the mean for equity returns.

Perhaps this is the way the bull market will end: not with a bang but with a whimper. Or perhaps this is the pause that refreshes for the economy and the stock market. Perhaps the Federal Reserve is in the process of engineering the much-desired soft landing that will prepare the economy for a new period of long-term growth, with an attendant healthy stock market.

The trouble is, evidence exists to support both scenarios.

On the one hand (oops), we have an economy that appears to be slowing. We have higher oil prices that are sucking purchasing power out of consumers’ wallets probably more effectively than a quarter-point interest rate increase by the Fed would. According to some economists, the oil price increase could reduce the gross domestic product by three-tenths of 1%.

In addition, higher oil prices could ripple through the economy, sparking higher inflation, which the Fed then might decide to fight with yet another interest rate increase. Even if the Fed stops short of triggering at least a mild recession, higher interest rates would slow the economy and hold down equity prices.

signs are there

Signs already suggest that manufacturing is slowing, and retail sales late in the summer were disappointing, apparently affected by higher gasoline prices.

More of that could come. In addition, the strong dollar is hurting U.S. exports and multinational companies’ profits.

Meanwhile, tech stocks have been hard hit by slowing PC sales, and investors are questioning the future prospects of many of the dot-com companies. Investor wealth has not increased significantly this year and, in many cases, has taken a hit along with the prices of many high-flying tech stocks and dot-coms. If investors aren’t as wealthy as they once were, they may have already curbed their spending and may cut it more if the market doesn’t pick up.

All in all, it is not a pretty picture for the rest of the year and into next year.

But on the other hand (oops squared), while the oil price increase might slow the growth of the economy, the consensus forecast is for the GDP to still be a healthy 3%. In other words, economists see no sign of a recession.

It’s possible to have a market correction without a recession (witness 1987), but a bear market is often triggered by increasing signs that a recession is likely. Increasing signs of inflation also can trigger a correction, but other than the oil price increase, such signs are missing.

In addition, the supply of new issues in the pipeline does not look large enough to offset the number of shares being taken out of the market by mergers, acquisitions and stock buybacks. That is bullish and short term, though it could be reversed by a new surge of initial public offerings.

Another good sign is that investors have been salting a lot of money away in money market funds. According to analysts at Donaldson Lufkin & Jenrette, money market assets in the past year have grown 22% to $1.8 trillion. That’s a lot of purchasing power available if investors should decide the time is ripe to buy equities. So the case can be made for a resumption of market growth.

Investors pay their money and take their chances. This investor has decided that the market is likely to be almost flat for the rest of the year, if only because the market abhors uncertainty, and there is much uncertainty. There is doubt about both the economy and the outcome of the elections, particularly whether either party will control both the White House and Congress. Therefore, it’s safest to stay on the sidelines until the picture is clearer. As for next year, we’ll leave that to the experts.