Is the Stock Market Ready to Rally?

Article of the Week from Investing Daily

by Jim Fink, Senior Online Editor, Investing Daily

All year anxious investors have faced a wall of worry including:

• the endless European debt crisis,
• Collapse of commodity prices (including crude oil),
• Middle-East instability (Iranian nuclear threat, Syrian civil war, religious radicalization of Egypt)
• Increased tax burden and job-killing effect of Obamacare
• U.S. presidential election and  the impending “fiscal cliff” in 2013, promising automatic spending cuts and tax increases
• Record-low U.S Treasury bond yields and an 18-week low in the Economic Cycle Research Institute’s Weekly Leading Index may signal a new U.S. recession
• Chinese economic growth may be weak for “several years”
• U.S. employment report for June was weak

Despite these problems, it’s important to keep a few things in perspective:

• The June 29th EU Summit concluded with an agreement to bail out troubled European banks directly rather indirectly through loans to overly-indebted governments like Spain and Italy, thus forestalling a Euro crisis George Soros had warned was likely within three months if Germany did not blink. With Germany blinking, the Euro has a better chance of survival.
• Semi-coordinated central bank actions on July 5th: (1) The European Central Bank cut interest rates to a record low of 0.75%; (2) China cut interest rates for the second time in a month after not cutting for more than three years; (3) the United Kingdom initiated a new round of $78 billion in quantitative easing; and (4) Denmark and Kenya also cut interest rates.
• Michael Steinhardt, one of the greatest hedge fund investors of all time (24% annualized returns net of all fees), has evaluated the European situation and concluded that the situation is not as bad as feared. He is “more long than short” in stocks and is still betting against short-term U.S Treasuries. Bottom line: Steinhardt is betting against investor gloom:

There is a general sense that the economy is lousy and blah blah blah, the markets are positioned as such. I’m going the other way.

To be frank, however, nobody really knows what is going to happen in Europe. I agree with a comment Oaktree Capital Chairman Howard Marks recently made in an interview:

When I look at Europe, I’m the first to say, I don’t know what’s going to happen. The range of possible outcomes is extremely broad. I hear a lot of people tell me what they think will happen. Nobody puts a probability on it. Very few people share a variety of scenarios. So, what I say about Europe is I’m only sure of three things. Number one, I don’t know. Number two, nobody knows, and number three, if you ask an expert and you follow his advice, you’re probably making a mistake. I believe that strongly.

• Alan Greenspan, former Federal Reserve chairman, recently was interviewed on CNBC and said he is confident that the U.S. Congress will take preventative action to avoid the “fiscal cliff” from dragging the U.S. economy back into recession.

The fiscal cliff will be essentially kicked down the road, like the can. The reason basically is that nobody wants all of a sudden for all of those items to hit the economy at the same time. Ultimately at the end of the day, something will be done.

• Templeton Funds emerging-markets chairman Mark Mobius has one-third of the $50 billion in assets he oversees in Chinese stocks, sees the country growing 8 percent this year with no hard landing, and plans to invest at least another $1 billion in Chinese consumer stocks over the next two to three years.

The stock market’s positive price action may reflect the improving global macroeconomic background. For example:

• The S&P 500 and Nasdaq finished the first half of 2012 in significantly positive territory, up by 8.3 percent and 12.7 percent, respectively.
• June was the best month for the stock market since December 2011 for the Dow Jones Industrials and since February 2012 for the S&P 500
• The last trading day of June (the 29th) was the S&P 500’s best day of the entire year, erasing more than a third of the second-quarter’s decline in a single trading session. Crude oil had its best day in more than three years.
• The S&P 500 rose above its 10-month simple moving average in June, generating a new buy signal after last month’s short-lived (and wrong) sell signal. All three long-term moving-average indicators (10-month simple moving average, 10-month exponential moving average, and 12-month simple moving average) are now flashing “buy.” As technician Doug Short explains:

The bottom line is that these moving-average signals have a good track record for long-term gains while avoiding major losses. They’re not fool-proof, but they essentially dodged the 2007-2009 bear and captured significant gains since the initial buy signals after the March 2009 low.

• Tim Hayes of Ned Davis Research told Barron’s Magazine last week that the stock market is bottoming:

When digging into the details of the technical, sentiment, valuation, and economic factors prevailing today versus in 2011 and 2010, this year looks a good deal more like the less ugly 2010 pattern. The market is undergoing a “bottoming process” that should result in renewed strength in the second half.

• Jeff Saut, chief investment strategist for the Raymond James brokerage, believes that the stock market has already bottomed, hitting its low for the year on June 4th:

I am still treating the June 4 intraday reaction “low” of 1266.74 for the S&P 500 as the daily, and intermediate-term, low for this cycle. Worth mentioning is that the Volatility Index (VIX) remains below its 50-day moving average, which is currently at 20.50.  Typically when the VIX is below its 50-DMA the equity markets are in an uptrend. This is especially true when the SPX is above its 50-DMA.

Last Friday’s huge 33-point gain catapulted the S&P 500 to 1,362 — which is above its 50-DMA of 1,338. The VIX remains below its 50-DMA. In other words, all systems are go for an intermediate-term rally under Saut’s system!

According to the Stock Trader’s Almanac, July is weaker than normal during presidential election years and the month marks the beginning of the worst four months of the year for technology stocks. Analyst downgrades of “almost every sector of technology” started right on cue last week, so near-term caution is advised in the tech sector. Goldman Sachs was disappointed with the Federal Reserve’s decision to do nothing but extend “Operation Twist” for the remainder of the year and consequently recommends shorting the S&P 500 down to 1,285, but even if this were to occur stocks would remain above the June 4th low of 1,266.

To end on a bullish note, the last seven months of presidential election years are historically bullish for the S&P 500. Furthermore, two sentiment indicators are screaming buy signals:

• Citigroup’s “Panic-Euphoria” model projected a 96 percent probability that the market would rise over the coming 12 months (as of May 25th).
• Bank of America Merrill Lynch’s Sell-Side Indicator is at its lowest reading in 15 years, which is a contrarian buy signal that projects an average 22-percent rise in the S&P 500 over the next 12 months.

Bottom line: I’m feeling more bullish.

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