We attempt to vary the topics we write about, but the last several weeks, we guess years for that matter, the market has held center stage in the financial, economic, and geo-political arenas. With so much at stake around the world the daily measuring stick of value has been on a ride the last several weeks most prefer to avoid. This is no time to employ an ostrich strategy when shepherding your funds, that was the strategy for the eighties and nineties.
For over a decade ago we have been mostly skeptical about the state of the markets, the economy, and the influence Washington has over both. Some claim we are just flat out pessimists. Our response is generally we would rather be wrong holding cash than wrong holding stocks. There are times when the stock market appears to be in a more cooperative state and this is when skepticism should be replaced with calculated execution. We believe we are at one of those junctures with a decent “Wall of Worry” set up to be scaled. We will cover a few dynamics that we feel supports that stance.
Europe’s Woes
The balance sheet issues of the Eurozone have dominated the headlines for a while now. We thought it interesting that similar news which came in February about the possibility of unrest in Greece unfolding did not even form a speed bump for stocks then. To us it appeared inevitable what is currently unfolding has been in the cards for a while. Could the market have over-reacted to the European news?
The bad news for Europe could be good news for the U.S.. The economic weakness that austerity programs will probably generate in Europe may have a negative effect for our companies doing business there. The upside is that with the contagion fear that has gripped investors may drive them to look for the countries with the strongest currency or printing press to invest their funds. The US Dollar Index has appreciated 14% this year. Concerned investors could look to U.S. securities for some degree of safety and growth. Those fund flows could help with our economic recovery as well as increasing the value of our stocks and bonds. Someday our currency may relinquish its global standing, but currently we still are the world’s economic power.
Bearish Sentiment
As we mentioned the headlines have rocked the markets for the last several weeks. Greece, California, unemployment, oil spills, and flash crashes have put investors into an escalated fear mode. Investor’s Intelligence conducts a weekly poll and the number of Bears reached the highest level in a year. Market lows have historically coincided with high levels of bearishness and peaks with bullishness. Bullishness was near all time highs in late April just prior to the correction .Anecdotally we have noticed a decided increase in the number of cautious talking heads on CNBC, the most watched financial channel. CNBC is known more for their cheerleading so we take this as also a positive sign. Currently we cannot find anyone who is wildly bullish at this time and the market has an interesting habit of making the herd wrong.
Corporate Earnings
The last few earnings seasons have been viewed as stellar. Second quarter results will begin in earnest within the month. The reporting trend recently has been for companies to under-promise and out-perform. According to Bloomberg projected 2010 profit growth for companies in the Standard & Poor's 500-stock index has climbed seven percentage points this quarter, to 34 percent. Sanford Bernstein says that is the fastest since 1980. The paring down of most company workforce’s has increased productivity and created many lean expense ledgers. Top line revenue has begun to trickle in and most of that goes straight to the bottom line. A jobless recovery is not the most ideal situation, but the stock market might appreciate the stronger earnings results and move higher?
Correction Overdone
Last fall it appeared that many institutional managers were under invested fearing that the credit meltdown would make for an extended recession. As the market moved higher many realized they were behind the curve and they began buying aggressively. Every pullback was short lived, and the move up was relatively relentless. With the fall of 2008 still fresh in investor’s minds the news of the last month created a rush to the cramped theater doors. It seemed as if they were hitting the sell button and asking questions later. That dynamic may have contributed to why this correction appeared so swift and scary. That is often how value is created and they may end up chasing performance again.
November Elections
One of the more important mid-term elections will be upon us quickly and even the primaries are becoming statements for restless voters. The Obama administration spent quite a bit of goodwill with the Health Care Bill and Democratic Senators and Representative may be expecting some help. One of the tools in an administrations kit is the Working Group on the Financial Markets also known as the Plunge Protection Team. This group was designed to mitigate market dislocations like the Long Term Capital issue in 1998. Many feel they are often used to keep the markets from correcting so investor and consumer confidence is kept at a healthy level. Making the markets and economic numbers look good during campaigns is just politics as usual. No specific empirical data on this group, but you know politics.
Technical Backdrop
The work we do revolves around charting and technical indicators for the market. Many of the indicators we follow are suggesting that the correction is at or close to an end. One of the more easy to understand indicators is the advance-decline line. Every day the number of advancing stocks is compared to the number of declining stocks and that information is charted. The chart below is that of the A/D line for the Nasdaq Composite and you can see that the current level is still above the lows that were made in February. The NYSE has a higher A/D line than February also. This is considered a positive divergence and often means the markets bigger picture advance is probably not done yet. As we mentioned there are several other indicators lining up with the A/D line at this time pointing to the correction’s end.
Conclusion
To us these data points individually are suspect, when they show up in a collective manner such as this it is worth paying close attention to. We do not believe the Secular Bear Market is over and the recovery still could face significant challenges. We think the next few months could produce a rally worth participating in, We believe we could even take out the April highs. As always we have an exit strategy and if the S&P 500 were to slip below 1040, about 9750 on the Dow, we would closely re-evaluate the situation. One of the strategies in Secular Bear Markets is to participate when the market is cooperative and this could be one of those periods.
Did You Know
THE MONTH OF JUNE - The last time the month of June produced at least a +2% gain on a total return basis for the S&P 500 was a decade ago (i.e., June 2000) when the stock index was up +2.5%. Last June, the S&P 500 gained just +0.2%. Over the last 20 years (1990-2009), June has averaged a 0.3% loss. The best “June-to-December” total return performance for the S&P 500 in the last decade (i.e., 2000-09) took place in 2009 when the stock index gained +22.8% over the final 7 months of the year. The worst “June-to-December” result took place in 2008 when a loss of 34.5% occurred (source: BTN Research).
Final Thought
“Knowledge speaks, but wisdom listens” – Jimi Hendrix
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