Markets ALWAYS Revert to the Mean
That’s the real risk here. Right now, there’s not much holding this market up besides high expectations.

That’s why, although we don’t foresee a crash like last September or November coming, we do realize the markets have hit an unsubstantiated high. This will lead to a terribly frustrating market for many investors.

Investors who refused to take what the market gave them months ago missed out on a lot. They’re now forced to play catch-up. And with the economy looking better, they won’t mind shoveling more money into the markets.

That’s where the frustration will come in. There’s no doubt the economic numbers will improve. But the markets will not have to go up because almost all of it is already anticipated.

If you consider Grantham’s fair value for the S&P 500 of 860, the overall markets could have another 20% to 25% downside over the next six to nine months even if the economic news is good. If we use his 860 as the average – or mean – the markets could easily revert to that level even while the economic data shows steady improvement.

No True Recovery in Sight
Although the markets will continue to be volatile, we can’t forget we’re undoubtedly entering a period of slow growth.

Yes, the housing market will recover. The government extension and expansion of the homebuyers’ tax credit will help accelerate this in the short-term. But it won’t return to the bubble era anytime soon.

On top of that, it’s looking like the bailouts will continue indefinitely. This week the government announced it will be putting more cash into GMAC for more auto loans and leases, which is nothing more than a backdoor bailout to GM and Chrysler. Also, the dairy and beef industries have gotten bailouts too. Both of these appear helpful in the very short-term, but they merely stave off the natural, inevitable, and necessary right-sizing of the industries to put them back in a sustainable state.

Then there are the unintended consequences of healthcare reform, the impact of higher taxes, and the greater involvement of government across the business landscape. They will all weigh on the economy too.

So although we’ve been as positive as we can reasonable get here, we try to stay realistic too. Today’s GDP numbers were great. The rally was great. But the good news will lead to higher expectations. And we all know before great disappointments comes great expectations.

The recession may be over, but that could mean trouble ahead for stocks. Now is the time to tighten up stop-losses and be prepared to move when necessary. There’s a very realistic chance of the S&P 500 falling 20% in the next six to nine months even if the economic numbers continue to improve.

Andrew Mickey is Chief Investment Strategist, Q1 Publishing