What Kind of Market Rally Is This? 16 comments
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In two previous articles, “This Rally Is Sustainable” (May 13, 2009) and “This Rally Is Sustainable: Halftime Report" (July 22, 2009), I took the position that the stock market rally made sense and could well continue. These articles were not meant to be forecasts or predictions, but simply to be arguments, based on facts and logic, that the rally might not come crashing down instantly, as so many were saying.
Now that we are more than five months into the rally, it seems like a good time to step back and see what we’ve got on our hands. I see five salient points:
- A stock market rally in the face of a contracting economy—that is, during a recession—is not unusual. Eight of the last 9 recessions have had such rallies. One might say that this is a garden-variety late-recession rally. The investors driving the rally are reacting to the anticipation of the end of the recession, not to actual current growth in the economy. There is no broad current growth in the economy—we are still in recession. The catalyst for the rally was/is the anticipation that the recession will end within a matter of months.
- That anticipation, in turn, has been supported by “green shoots”—that is, indications that the recession was ending. Green shoots do not have to indicate that the economy is expanding. Data that suggest that the economy is getting “less worse,” or declining at a slower rate, qualify. Obviously, for any economic contraction to end, it must first slow down its rate of contraction, reach a point of inflection, and then start actually expanding. So a data point that suggests the economic contraction is slowing, or is cause for optimism on some level, has “counted” as good news, at least until now.
- Because the rally is in anticipation of the end of economic contraction, the market is basically sentiment-driven. Good news helps the rally along, while bad news slows it down or reverses it.
- The fact that the rally is sentiment-driven is the answer to those who have been surprised and perplexed by its sustainability. Such investors and writers have insisted that the rally is not supported fundamentally, therefore it must fail. They are correct that it has not been supported fundamentally. But they have underestimated the power of “less bad” news, or signs of a slowing contraction, to create and sustain a rally. For example, about 75% of companies beat consensus earnings estimates in the second quarter. During the reporting period just ending now, the market advanced by about 14%. Clearly, it was the beating of the estimates that the market relied on to bid up the prices of stocks during this period. The facts that those estimates had been lowered significantly to low hurdles, and that most earnings were significantly reduced year-over-year, were not driving sentiment—beating the estimates drove sentiment.
- Since the rally began on March 10, the net news flow has been, on average, pretty steady in indicating slowing contraction and a coming end to the recession. Therefore the rally has continued more or less steadily, with only an 8% pullback during June and July to interrupt its progress. The rally has expanded the value of the S&P 500 by more than 45% since it began in early March.
So what we have is a late-recession, sentiment-driven rally, where the predominant sentiment has been that the recession is ending and the economy will soon start to expand.
But we have reached a point that expectations are now built into the market of an actual end to the recession and an impending turnaround into an expanding economy. The market is not “priced for perfection.” Rather, it is priced for an end to the recession and the beginning of economic expansion. (It may or may not have gotten a little ahead of itself in anticipating an end to the recession and the beginning of economic expansion--which is to say, a correction may be in order.)
But we have reached a point that expectations are now built into the market of an actual end to the recession and an impending turnaround into an expanding economy. The market is not “priced for perfection.” Rather, it is priced for an end to the recession and the beginning of economic expansion. (It may or may not have gotten a little ahead of itself in anticipating an end to the recession and the beginning of economic expansion--which is to say, a correction may be in order.)
Over the next few weeks, the expectations placed on the news flow will become different: “Less bad” news will, at some point, no longer count as “good” news sufficient to support a continuation of the rally. Instead, the market will start to demand data that show:
- The Conference Board’s Index of Leading Economic Indicators continues to rise each month without interruption.
- Consumer confidence is rising.
- Consumer spending is increasing. Look to the back-to-school season as an important indicator here. At more than two-thirds of economic activity, consumer spending is a necessary factor in an economic recovery.
- Manufacturing is increasing, and manufacturing capacity is being utilized to a fuller degree. Inventory reductions are continuing.
- Real estate sales are picking up. Better yet would be data that housing prices have stopped falling, but just an expansion in residential sales activity would probably be good enough for awhile.
- Earnings are growing on a sequential basis, and closing the gap significantly on a year-over-year basis. Since the next reporting season is two months away, look for rising estimates, optimistic guidance, and the like. Everybody is aware that Q2’s earnings “successes” were built upon layoffs and cost reductions, not expanding business activity. Indeed, most companies reported drops in revenue in Q2. That won’t cut it for very much longer.
- Stock valuations are not heading into the stratosphere. Note: Investors already seem to have signaled that they are willing to look past the S&P’s soaring trailing P/E ratio (the result of Q4 2008’s dismal negative earnings), and to consider projected P/Es, or P/Es calculated on operating earnings, in valuing stocks at the current time.
- Layoffs are slowing significantly, jobs are being created, initial unemployment claims are falling, and the unemployment rate is falling.
There are those who say that good news of this kind is impossible, because both consumers and businesses are deleveraging and will not be expanding their activities any time soon. There is certainly logic behind their point, but I believe that nobody knows the future. After all, the market has surprised many for five months now, there is certainly a possibility that it might continue to do so for another month or two. My suggestion is to listen to the news flow, keep current with what’s actually happening in the market, and protect long positions with hedges or simple sell-stops.
Disclosure: Long IBM, SPY, and QQQQ based on the reasoning above. Also long about 15 dividend stocks based on another strategy.
Disclosure: Long IBM, SPY, and QQQQ based on the reasoning above. Also long about 15 dividend stocks based on another strategy.
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This article has 16 comments:
The kind that's playable by casino players, wall-street speculators and mad investors.
Current market/economic/sentiment conditions are not as favorable. I booked profits and have hedged remainder with puts as per prior post last week. Wouldn't surprise me to see if we are on the downslope of the "W" point in our market.
Mostly in tiny fractions of percentage points, indicating we could well experience a "statistical recovery", rather than on actually felt on Main St.
"Consumer confidence is rising."
Except for last week's numbers, and as foreclosures, bank failures, etc. continue to grow, I'd be surprised to see any big bounces upward.
"Consumer spending is increasing. Look to the back-to-school season as an important indicator here. At more than two-thirds of economic activity, consumer spending is a necessary factor in an economic recovery."
That is/will be contingent on consumer confidence, see above. Anecdotal evidence shows a weak back to school season.
"Manufacturing is increasing, and manufacturing capacity is being utilized to a fuller degree. Inventory reductions are continuing."
After taking out the artificially induced bump in auto sales, mfg. doesn't look so good. Inventory reductions are a reflection of companies coming to grips with the "new normal".
Shall I go on?
Get your Titanic tickets now, because the latest report came in indicating she was sinking more slower and was at or near the bottom, indicating that maybe the worst was over.
On Aug 17 08:53 AM LT Trader wrote:
> The rally wasn't a surprise. Sentiment was at historic lows, MACD
> were showing positive divergences and it was the "end of the world".
> Hence, S&P up 50% or so, plus small-value indices up 70-80%.
> Also, a lot of Fed jawboning and support of banking stocks that helped
> propel banks higher. Plus, at a certain point, one should not fight
> the tape.
>
> Current market/economic/sentiment conditions are not as favorable.
> I booked profits and have hedged remainder with puts as per prior
> post last week. Wouldn't surprise me to see if we are on the downslope
> of the "W" point in our market.
This is one damn fine bear market rally IMHO, and i love it!
Well if Monday is a fast selling, what makes the difference Tuesday will not be one? If people decide that this ride is over, they might as well push the sell button!
On Aug 17 06:14 AM rick12345 wrote:
> Despite any fundamentals, the markets will experience a correction
> Monday and Tuesday. Panic selling will ensue on Monday following
> Friday's late lead, hopefully slowing down on Tuesday. Wednesday
> should see the vultures hovering over Wall street in search of dead
> carcasses. The good thing about this correction is that the world
> economy is now travelling uphill (albeit slowly) rather than descending
> at a blistering pace. I can't see too many of the retail buyers consolidating
> losses, so I would expect 9000 - 9200 at worst. Of course it could
> go lower, but I'm choosing to ignore the bears' call (bluff).
By Daniel Thomas, Property Correspondent
Published: August 17 2009 04:03 | Last updated: August 17 2009 04:03
The number of “distressed” commercial properties coming to the market rose in every region in the world in the second quarter, with the UK in particular seeing a rise in interest in property sold by owners experiencing problems.
According to a study on Monday by the Royal Institution of Chartered Surveyors (Rics), more than three-quarters of the 27 countries surveyed saw a rise in distressed property sales in the second quarter compared with three months earlier.
IMO-Sorry I cant see, the light in this tunnel is so bright, are we getting near the end of this, thats what people have been saying, whats that noise, sounds sorta like a train! Are we on a train track?
I'm late in long, and looking to get out as soon as, preferably with a profit, but I'll take a loss to avoid the big drop I see coming, but unfortunately like everyone, I can's say when.
All of this panic is great as I'm picking up some great bargains.
To date three major economies, Germany, France and Japan have emerged from recession, with England soon to follow. China and India never went into recession while Australia had 3 months of -0.1 growth. Iv'e said it before and I'll say it again, but it's amazing how consumer based economies such as the US are lagging the rest of the developed world.