Market Outlook: We're in the 'Bounce Phase'

The following are links to several articles I found interesting over the past week or so.

First, a comment on the market.

I am still substantially net long but have not bought or sold anything over the past while. However, I am more of a seller than a buyer at these levels.

The trend is still up though, with the S&P 500 trading at about 14x normalized earnings of $68 a share, the market is more than fairly valued. Economic and financial apocalypse is off the table but the economy still has structural problems such that earnings and equities returns will be capped for some time.

I believe that today's market most closely mirrors the latter half of the 1970s or the late-1930s to early-1940s when the market bounced hard off the bottom then meandered for several years. We are currently in the bounce phase, and my playbook is for the S&P 500 to get over 1,000, but I am more than willing to change my mind if it appears the market is rolling over. However, the market is showing no signs of turning, so the trend remains up. It gets tricky when the uptrend ends.

I rely primarily on fundamental analysis when investing, but I also use technical analysis as a tool for entry and exit points. Paul Tudor Jones - perhaps the greatest hedge fund manager of all time - explains why technical analysis is important.

The inability to read a tape and spot trends is also why so many in the relative-value space who rely solely on fundamentals have been annihilated in the past decade.

Today there are young men and women graduating from college who have a tremendous work ethic, but they get lost trying to understand the logic behind a whole variety of market moves. While I’m a staunch advocate of higher education, there is no training — classroom or otherwise — that can prepare for trading the last third of a move, whether it’s the end of a bull market or the end of a bear market. There’s typically no logic to it; irrationality reigns supreme, and no class can teach what to do during that brief, volatile reign. The only way to learn how to trade during that last, exquisite third of a move is to do it, or, more precisely, live it — a sort of baptism by fire. One has to experience both the elation and fear as markets move five and six standard deviations from conventional definitions of value.

The OECD believes the global economy is approaching a low.

Most of the world’s big economies are close to emerging from recession, according to data published on Monday by the Organisation for Economic Co-operation and Development that pointed to a possible recovery by the end of the year.

The Paris-based organisation reported in its latest monthly analysis of forward-looking indicators that a “possible trough” had been reached in April in more developed countries that make up almost three quarters of the world’s gross domestic product.

The composite index for 30 economies rose 0.5 points in April, the second monthly rise in a row, after falling for the previous 21 months. The index seeks to identify turning points in the cycle about six months in advance.

The OECD said its overall measure of advanced member countries – ranging from the eurozone and the UK to the US, Mexico and Japan – now pointed to “recovery” instead of the “strong slowdown” they had been suffering since last August.

Good news. Fewer and fewer Harvard grads are going into financial services. Generally, tops are marked by more grads going into financial services and bottoms by less grads going to Wall Street.

The number of graduating Harvard seniors entering finance and consulting has fallen by half in the past year, the Harvard Crimson’s annual survey found. About one fifth of all seniors seeking full-time employment are taking jobs in one of the two sectors.

The number of seniors entering finance and consulting has fallen from 47% in 2007 to 39% in 2008 to 20% for the current Class of 2009. The financial sector saw the largest reduction, falling from 23% to 11.5%, while the share of seniors entering consulting fell from 16% to 8.5%.

Sam Zell says that commercial real estate is far from dead.

While it is true that there will be a few implosions, a housing style bust may not be in the offing. A simple reason may be the string of payments. Unlike a homeowner who loses their job then their home, the owner of CRE has a buffer. First the rents of the tenants pay the loans, and only when they are not enough to cover, do[es] the owner then dip into their own pockets.

In short, the risk/payment responsibility is dispersed among several parties. Again, this is not to say that there will not be defaults, [or even] many of them or that REITs will not suffer, it is just the widespread and pervasive losses we are seeing in RRE may not be in the cards (losses here are defined [as] foreclosures on CRE).

Tobin's Q may be signaling a low in the market.

Finally, hedge funds still have too much cash, which could power the market higher as lagging hedge fund managers put cash to work.

The fast money is proving slow to jump on the market's bandwagon.

Hedge funds, decried by many as quick traders, have played catch-up during the market rally since March. The average fund was 45% "net long" as of May 19, or had investment holdings valued at 45% more than its bearish "short" positions, according to Hedge Fund Research.

That figure is up from 33% earlier this year, but still is far below its 55% level a year ago. Funds are less bullish now than they were just before the market crumbled last fall.

Hedge-fund managers, and their investors, said many remain in a neutral position. Hedge funds tend to underperform stock-market averages at inflection points, in part because they aim to create a "hedged" performance, rather than ape the market.

Comments

[xxxx:]

hedge funds have put their money into other asset classes because they realize the market is being manipulated and the overall economy has major flaws. "commodities" as hedges of inflation

"Europe’s Dow Jones Stoxx 600 Index advanced 2.1 percent. The gauge has rebounded 36 percent since March 9 on speculation that the $12.8 trillion pledged by the U.S. government and the Federal Reserve will help end the first global recession since World War II. The index is now valued at 24.9 times the earnings of its companies, the most expensive level since 2004, weekly data compiled by Bloomberg show."

Jun 10 08:04 AM

[AndrewBaker:]

Good article with sound reasoning. I agree that education today is generally poor and many people working now did not learn enough about the world and what makes it move to have much of an idea of how to gauge and value economies and sectors, let alone individual companies. So volatility is to be an expected result, which includes this recent false bull move.

Further, there is a wall of money out there, whether TARP, retirement or other savings funds, or hedge fund cash trying to play catch-up. This may well push prices higher, especially as summer has lower volumes, but later this year, and after more results and news have come out, a reversal will come. We're not out of this yet.

Jun 10 09:08 AM

[enigmaman:]

they say the market " Climbs and wall of worry" and they also say the "Market does not like uncertanty" I dont see the difference, Worry comes from Uncertanty and Uncertanty comes from Worry
The market has been climbing dramatically for the last three months, nothing in this market is like in the past, there is no correlations because the fundamental changes coming to our economy will negatively impact businesses, tax payers, lifestyles all changing every aspect of our lives as we ahegv groiwn accustomed but the market shakes this off as if they dont care. Its as if the market is telling us the Free Market as we know it is dead, Long live the new World, the New Normal, I dont get it at all.

Jun 10 09:29 AM

[Leftfield:]

I'm struck by the Harvard data. Two years ago 47% went into finance. The rest go into politics or law. All of the most screwed-up places that are bleeding the rest of us dry. I understand why Wm. F Buckeley said he'd sooner choose names chosen at random from a phonebook than from the Harvard faculty for leaders.

Jun 10 09:34 AM

[Mad Hedge F...:]

Ouch. zThe market has gotten so dead here that I have started watching Suzie Ormand to get trading ideas. So I’m not supposed to run large balances on my credit card? Who knew? A hedge fund friend told me that the market is now like watching a ball tossed in the air that is at the apogee of its move, just before the free fall begins. No news, with shrinking volume and volatility. General Motors (GM) isn’t a stock anymore, so all of the news flow there might as well be a History Channel documentary. You can only sell so many out of the money short dated calls on other stocks before bumping up against risk control parameters. Even if you do make money in these conditions, it is at the expense of a Maalox addiction to fight the multiple holes in your stomach. It’s not worth it. This is why I prefer to spend my summers mountain climbing or practicing my ballroom dancing. Please see my “Sell in May and Go Away” opus at (www.madhedgefundtrader... ).

Jun 10 10:33 AM

[Larry House:]

Thanks, Toro. Useful ideas. The trend is still up, but it is not to be blindly trusted. I am expecting a correction like many others, but that is the very reason the market may not cooperate. That is why I have long positions as well as cash.

Jun 10 10:40 AM

[ebworthen:]

Sell now.

The DOW is just now going over the 200 day SMA and the 50 day EMA is about to touch it. This will be the peak of this speculative rally; big correction after that.

This correction will catch a lot of people with their pants down, and make many individual investors get out or not get back into equities.

Fund managers may want to feel pressured to put money back into equities, but if the millions of retired and other IRA and 401K investors decide to move or keep their money out of equities the market won't be going up.

Jun 10 11:01 AM

[Donald Ingram:]

This is a six month bounce, come this Autumn the markets will roll over and zoom right on down past the March lows. The subsequent bounce will give rise to a "last gasp" rally - post Christmas into early Spring before totally capitulating at Dow 1450.
Someone once said that opinions are like A,holes, everyone's got one! Well, this is just my opinion and am planning on just such an outcome.
To each their own. Keep your shorts up!

Jun 10 11:20 AM

[Mrudula Shah:]

My thoughts and analysis are at variance with several commentators above. I agree that the present-day graduates (including those from Harvard) are primarily computer-guided and (of course computer-savy). Consequently, their intellectual diagnostic ability often lacks common sense and consideration of human factors. Their models, however, can account for a lot of technical factors hitherto not possible (a plus), but human-psychology and big-picture based factors are not so easy to visualize and to be incorporated into. The modern-day executives (especially those at the finanacial corporations like banks) have been brain-washed by these modern-day "Harvard" finance-major graduates and faculties. Also, these generally greedy executives look for is short-term profits and having lost their ability to look past it. Thus, the mess we are in now. However, this is precisely the world we are in now and must learn how to live with it and survive.

Regarding the securities market, I believe, the companies will continue posting significant losses for the current quarter through July and mid-August this year, keeping the market subdued. However, due to the siginificant steps the companies took throughout this period of turmoil, combined with improving credit and business conditions, a lot of these companies are likely to begin posting better conditions or results during the Fall. This, alongwith infusion of cash sitting on the sidelines, the market is most likely to trend upward during and after the Fall. Prediction for the modern-day computer-dominated world, based on certain technical analyses that consider the past history when the computerized world was virtually non-existent may point differently!!

Jun 10 05:58 PM

[Tomcat101:]

I thought the treasury auction's poor results today would have caused more excitement than it did. SP went down a whopping 1% or so and then gained most of it back by the end of the day. No big deal. What's it gonna take to scare these people? I'm starting to think that Russia could invade Alaska, oil go to $600 a barrel, Obama drop dead of a heart attack, and an asteroid hits Washington D.C. and this market would continue to rally.

I think that this joy and euphoria will quickly dissipate in the near future when we see the toll that high gas and high mortgage rates are taking on the fragile consumer. It's just a matter of how long it takes to start showing in some key reports. Then this massive game of musical chairs comes to a screeching halt. Don't get caught chairless.

Jun 10 06:06 PM

[dragonpaw:]

fazde; aren't we all! The gov't will not manage our money better. All elected "jobs" i.e. congress ,senate,gov's, et al ad nauseum, are set up to buy votes. We have bought what we got! They have bought from an electorate that is un-educated, unconcerned,un-motivated, and politically inept.
We may survive until the next (sic) election; emphasis on (sick); but other world powers (notably China,Russia, Germany [sieg heil], the conglomerate of lesser assuming billionaires [George Soros and friends] , may not wait until this happens.
If and when this happens, the world may experience a cataclysmic change that world financials have never seen. The "soundness" of the dollar (as oxymoronic as this sounds even today) may prove as elusive as all the "forecasting models."

Jun 10 10:46 PM

[Moon Kil Woong:]

The bounce already happened. What we are seeing today is the apogee

Graduating students are not picking to go into finance or not, they are going into anything they can get. Thus such graduating surveys are less pertinent in a recession.

The one thing I agree with is that there is a lot of money on the sidelines. This is money trying to get out of low interest fixed rate investments (not hedge fund money). Whether or not they are willing to accept risky possibly negative investments is the key. So far, the answer has been yes, they are willing to risk a little. That's why the market hasn't been falling like it usually does when higher interest rates appear.

Jun 10 11:08 PM

[montyman:]

That's great Jerry baldy, but WHEN? 2012??


On Jun 10 10:17 AM Jerry baldy wrote:

> This market is in for a sharp correction downward. Many people are
> going to be caught long, the author of this article included.

Jun 11 03:33 AM

[Maya_:]

Why is 14X overvalued? If we use a long rate of 2.5% and a risk premium of 5% and long term real earnings growth of 2% (same level as GDP), the index should command a multiple of 17. Based on $68 in real earnings (which I think is on the high side for as reported earnings but okay for operating earnings) the SP500 could be at fair value at 1143. That is the long term.
As far as near term is concerned, I expect the markets to weaken in q3 as focus shifts to post stimulus earnings expectations. Leading indicators are strong on the back of stimulus spending - another round appears unlikely because of the rather large deficits. The leading indicators will likely weaken during q4 unless private spending picks up to fill the gap left as stimulus spending peters out. An increase in private spending will come, but possibly at a lower levels compared to the recent past. Savings rates are begining to look more reasonable now and common sense says they should stay that way. All in all private spending should recover, but not enough to replace stimulus spending. The good news is that increased savings goes a long way in deleveraging consumers. In addition, savings means investment for there is little else that can be done with money - money gets spent on consumpsion, what is left is saved, what is saved is invested - this liquidity is supportive for asset prices; at the same time reduced consumpsion keeps consumer inflation subdued. Ultimately rising commodity/asset prices should feed through to inflation; but provided wage inflation stays under control, CPI should remain below 3%.
So while markets are reasonably valued on a long term basis, I would look for a decline to 800-825 to put new money to work. Technically I would like to see the markets fall and hold 5% above the November lows; if this occurs we can be relatively sure that the March lows were the bear's bottom!

Jun 11 11:28 PM