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

by: Toro

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.

Tobins Q

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

Click to enlargeThe 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.