Todd Salamone: Stock Uptrend Intact, Expect No Sharp Pullback

Todd Salamone is vice president of research for Cincinnati-based Schaeffer’s Investment Research and also manages the "Put Selling" portfolio in Bernie Schaeffer’s Option Advisor newsletter. His comments have appear in several publications, and he is interviewed regularly on CNBC. To read his comments every Monday morning, see here.

H.L.: How strong is the economy in light of August’s 9.7 percent jobless rate, up from 9.4 in July, and the decline in job losses from 276,000 in July to 216,000 in August?

T.S.: There still seems to be a lot of concerns and doubts surrounding the economy, especially as it relates to the employment numbers. We think this is a positive, since stocks, especially in the consumer discretionary area, are more apt to respond favorably to positive surprises and less negatively to poor numbers that may already be reflected in share prices.

The stock market seems to be indicating that the economy is stronger than expected. We view this as a positive for the longer term, as many believe the market has surpassed fundamentals. In other words, while stocks seem to be discounting favorable news on the economy, many investors are expecting poor news on the economy, and, thus, sitting on the sidelines, waiting for a retreat. This money represents cash that can support the market on pullbacks and also keep intact the current uptrend from the March lows.

H.L.: Can the economy grow before there’s some hiring?

T.S.: Yes. That could be evident in strong productivity numbers we’re seeing. This puts some companies in a strong position from an earnings perspective, even as many investors seem to be extremely cautious about earnings driven by cost-cutting.

Even a slight increase in top-line growth amid expenses that are relatively low could create very favorable margins in the future, creating an environment of continued positive surprises.

H.L.: How do you read investor sentiment?

T.S.: We’re seeing a lot of skepticism in the context of the uptrend. Retail investors, for example, according to the American Association of Individual Investors, have been noticeably negative throughout the summer months.

Professional investors seem to be retreating to the sidelines as well in anticipation of higher volatility in September and October.

From a contrarian perspective, the negative sentiment that we are seeing is a positive within the context of the current strong price action in equities. That being said, from a technical perspective, there will be continuous hurdles for the benchmark S&P 500 to overcome in the weeks and months ahead. For example, we see major resistance in the 1,000 to 1,040 area on the S&P. This could create sideways action before the next leg higher, but we, as opposed to many others, are not expecting a sharp pullback.

HL.: What stocks do you recommend?

T.S: We are currently favoring the consumer discretionary area, financials, and technology stocks. Some of our favorites include Netlogic (NETL), Palm (PALM), AutoNation (AN), Polo Ralph Lauren (RL), Starbucks (SBUX), Citigroup (C), Aflac (AFL), and Credit Suisse (CS).

We just think these are sectors that have rallied significantly, but there really isn’t a lot of buy-in. There are a lot of skeptics out there doubting that the trends in these equities will persist.

H.L.: You said there’s a lot of skepticism. What are people afraid of?

T.S.: There’s a number of factors, ranging from skepticism about the Federal Reserve either removing stimuli too early, thus hampering a recovery, or removing stimuli too late, therefore fostering inflation. There’s a lot of skepticism relating to the consumer in terms of debt load, unemployment trends, and a higher savings rate. Since the consumer is such a major part of the economy, consumer-oriented concerns translate into skepticism related to the economic outlook.

Other areas of fear relate to what is happening in the commercial real estate market, corporate earnings, upcoming regulations and reforms, and the “we’ve come too far too fast” mentality.

H.L.: What's troubling commercial real estate?

T.S.: There are some definite fundamental issues, relating to load defaults, refinancings, and the possibility of a relapse. However, unlike the housing crisis, I think the Federal Reserve is aware of them and is prepared to deal with them much more quickly than it did with the housing bubble.

What also is important is that the issues have been so well-publicized that they could be factored into the stock market.

H.L.: When do you think the economy will actually start growing?

T.S.: Expectations are that the second half of the year will show a rebound. Should this not occur, it would be a disappointment. While we cannot say what 2010 holds, there does seem to be a huge number of investors betting on a U- or W-shaped recovery. Should a V-shaped recovery take hold, the stock market would advance much more strongly than anyone anticipates.

Comments

[Billy Ford:]

Its funny how people like you are saying that bad news is already built into share prices, but yet we are at 19x earnings. We saw decent earnings compared to ULTRA conservative expectations only on cost cutting. I would guess that the results of cutting costs were Q2, so Q3 better bring some increased revenue to the table which I am very skeptical. This stock market is propped up on the fact that we think people will begin to go out and spend. With real estate still in the dumps, record foreclosures, unemployment at 9.7 and climbing, I am highly skeptical of people rushing out to buy anything. This consumer deleveraging process will take a few years to say the least. It is easy for people to jump on the equity bandwagon when there is a 7 month rally, but you will be the first ones to change your view once you realize that we were simply having a correction to the upside. I dont foresee any sharp legs down, but do believe we are in for a slow decent down from here over the next 6-9 months. What is going to move us up from where we are now besides increasing multiples?? You would have to be crazy to buy into this market right now. I would much rather miss a move higher than to get slammed in the next 6 months.

Sep 08 11:22 AM

[conceptwizard:]

I agree, as long as those HFT computers are at work their will be no decrease in the stock market. It will be allowed to bubble as everything else is also trying to be inflated. Housing, Automotive. But it is all a falsely created fallacy. The economy will deleverage regardless of what anyone tries to do. The Consumer will see to that, he just has not and will not spend. That is the one thing that these dumbbums dont control (yet) . THE US CITIZEN.

Sep 08 01:57 PM

[Dirtnap:]

The stock market no longer correlates to any fundamental strength in the economy; atleast, no more than drawing 21 means you're good at blackjack.

Sep 08 04:13 PM

[Albertarocks:]

It doesn't matter what argument is thrown at Mr. Salamone as reasons why investors might be feeling negative or worried, he has a way of seeing it through rose colored glasses. He has an answer to counter every single concern or piece of logic as to why the markets could fall. Guys like him usually get hired by CNBC. The only reason I'd give him a second listen is that he works for Bernie Schaeffer who I've had a lot of respect for.

But c'mon, there are legitimate reasons out there to suspect that this market isn't going to continue going up forever, especially when volume has been declining steadily since the very first week this rally started back in early March. I'd trust Mr. Salamore a lot more if he would at least acknowledge that some of the dangers out there are very real.

Sep 08 06:17 PM