Equity Markets, Earnings Looking Good; Stage Set for Another Upside Leg?

Excerpt from Raymond James strategist Jeffrey Saut's latest essay, published Monday (July 20th):

...[T]he stock market didn’t seem to care about such political agendas last week as the S&P 500 (SPX/940.38) tacked on another 7% to close the week around 940, thus negating the widely advertised head-and-shoulders “top formation” in the charts. The Weekly Waltz also left the SPX above its 10/30/50/200-day moving averages and in a position to challenge its June 11th closing high of 944.89. Bettering that level would suggest an attempt to achieve our long-standing target of 1050.

In Tuesday’s verbal comments we postulated this might be the case by noting that we were VERY impressed with last Monday’s action (+185 DJIA). Accordingly, we recommended that trading types consider buying the index of their choice with the appropriate short-term downside hedges. Surprisingly, that was the first trading position we have recommended in months. Even more surprisingly, it is currently profitable. In the investment account, however, for the past few weeks we have been recommending Whiting Petroleum’s (WLL) 5.8%-yielding convertible preferred. It too has proved surprising since our original recommendation; and we continue to embrace it, albeit now only on weakness.

As for what drove stock prices higher last week, as our economist Scott Brown writes:

“The data were mixed, but generally consistent with the view that the recession may be nearing an end. However, the recovery is expected to be initially sluggish, with continued weakness in the labor market. Retail sales were moderate in June, supported by higher gasoline prices (however, those higher gasoline prices restrained spending in other areas). Industrial production fell moderately in June, but the second quarter’s pace of decline was lower than the first’s. Residential construction activity improved further (single-family permits up three months in a row). The Consumer Price Index was boosted by higher gasoline prices – core inflation was moderate. The minutes of the June 23/24 FOMC meeting showed that policymakers viewed the risks to growth and inflation as somewhat more balanced than in April. However, downside risks to growth were seen as ‘still significant.’ Treasury yields increased on the data. The stock market rallied on good earnings results.”

Speaking to earnings, while we have been adamant earnings were likely going to look pretty good during the back half of 2009 when compared to the lousy back half of 2008, hereto we have been surprised by the 2Q09 earnings. Indeed, according to our friends at the invaluable Bespoke Investment Group, “This quarter’s ‘beat rate’ is currently 63.4%, which would be 1.4% better than the 62% we saw last quarter. If we’re able to stay above last quarter’s ‘beat rate,’ the market shouldn’t have any problems holding onto its uptrend throughout earnings season.”

To which we would add, this recession has been unique in that productivity actually increased. The only way this can happen is if corporations cut costs. The implication is that if demand picks up, the earnings rebound in the back-half of this year could be a lot stronger than most expect. And that, ladies and gentleman, could be the carrot in front of the proverbial horse.

The call for this week: We agree with the ... quote from Victor Niederhoffer, “Bureaucrats (and politicians for that matter) have little incentive to improve, invest or innovate. When speculators are wrong, however, they are punished severely for their mistakes by losses of their own money. If left unchecked, the tendencies of our modern kings to interfere with the natural working of the marketplace would lead to destruction.”

Still, despite what appears to be a somewhat wrong-footed political agenda, the equity markets “danced” to yet another Simon and Garfunkel song last week, namely “Bridge Over Troubled Waters.” Said “dance” produced a 90% Upside Day last Wednesday, leaving indexes like the DJIA and S&P 500 in a position to challenge their June “highs.” The implication is that we are either setting the stage for another “leg” to the upside, or are making a double top. Interestingly, a number of other indices, like the NASDAQ 100 (NDX/1527.26), have already breached their respective June “highs.”

Also interesting, the two groups that appear the least overbought currently are Energy and Telecom. Readers should know the energy ETFs we have been using, some of which contain Strong Buy-rated names from the Raymond James research universe like Nobel (NE) and 9%-yielding Inergy (NRGY). As for telecom, the two ETFs we offer for consideration are the 4.2%-yielding iShares Telecomm (IYZ) and the 4.8%-yielding iShares Global Telecomm (IXP). Hereto, there are some Strong Buy-rated Raymond James names like Nuance (NUAN) and NII Holdings (NIHD). And don’t look now, but Japan “felt” like it bottomed last week . . .

Comments

[Mark Mansfield:]

I find it stunning the extent to which the WLL common seems to have rallied as of late despite a little give back from earnings positive competitor such as XTO today.

Jul 22 11:16 PM