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Like some others, I am a bit surprised by the continuing strength in the market. Our emotionally driven caveman-era brains are still waiting for some other shoe to drop. On the other hand, I believe I do understand a portion of what is going on, based on my work with developing basic quantitative relative-value models. Maybe we will even see another 20% move higher in the market indices.

Many quantitative models do not care what is happening in the economy, the unemployment rate, or if a health care bill was passed or if taxes are going up. And these stocks do not care about stock prices -- where prices were yesterday or a month ago. Instead, these programs look at a multitude of fundamental metrics from a bottom-up and relative basis to every other stock. If a company's reported fundamentals are improving and if sell side analysts are raising estimates and raising targets, these programs are going to buy these stocks.

Additionally, many of these programs may not care what the long-term cash flow outlook is for a particular company. This is because the institutional managers running these quantitative programs must buy stocks whether they want to or not -- it's their job. Therefore, they let their programs run to find the best relative value as opposed to the best value. The best programs are looking at trends in the factors, and extrapolating where those factors are going to be in six months. It is why stocks like MGM Mirage (NYSE:MGM) and Las Vegas Sands (NYSE:LVS) are moving up -- if key operating metrics in a company have stopped going down, these programs are now extrapolating that they must be improving.

Indeed, if key fundamental metrics are improving, then there is a good chance these metrics will improve more than current sell side estimates -- that is because sell side estimates lag the market, not lead it. While it is hard to stand where we are and justify increased spending at casinos (are you planning on a trip to Las Vegas in six months?), it is where the numbers are heading. Estimate revisions can generate momentum of their own and sometimes develop into a self-fulfilling prophecy.

In addition, I think one would be also surprised just how many of these quantitative programs are simply technical in nature -- literally looking for thousands of patterns every second and matching up trades based on what has happened over every second for the the last five or ten years.

More specifically, it is why in February I suggested that growth managers purchase Starbucks (NASDAQ:SBUX). It is hard for any analyst, expert on coffee or not, to pound the table for FY2011 EPS coming in at $1.70 versus a consensus high of $1.41 and consensus average of $1.25 (as of Feb), which is what I think is required to justify a $30 target price. But if you need to buy a stock in the Consumer Discretionary sector right now, SBUX is still one of the best ones to buy on a relative valuation basis.

And in any case, why shouldn't SBUX EPS go higher than $1.70 by September 2011? It is certainly possible as people move from McMansions to smaller homes while keeping their Starbucks gift card replenished, and as the company rolls out VIA instant coffee, expands licensing efforts overseas and perhaps announces initiatives the company has not even thought of yet. Would you really want to bet against that scenario? If you cannot bet against it, you might as well buy into it, especially in this market.

So for the growth manager that needs to buy a stock right now, SBUX is a very easy stock to justify buying at the current price. For managers focusing on value, the boat has left without them. Maybe even a few are caving in and buying now. A professional manager may not want to buy a stock like SBUX, but he has to anyway. It is still the best choice.

If my reasoning is accurate, this market can keeping rising. There are so many stocks that have turned the corner fundamentally, that a relative-value approach can justify continued buying for at least another 20% move.

I am not standing here pounding the table for another 20% move higher in the S&P. I have no clue if that will happen. Should you buy now? My wise-guy answer is, why didn't you buy back on March 1, when our Ascendere Long/Short Model Portfolio, and probably a few others, turned net-long?

A more practical answer would be yes, if you are taking a hedged approach, you want to buy right now or next week. It does not matter. From a hedged position, you are at least participating. A net long weighting could be proven "wrong" immediately following execution. But if you are hedging your position in a "tactical-tilt" manner that a number of institutional wealth managers such as Goldman Sachs (NYSE:GS) and ourselves advise (see our back-of-the-envelope-attribution for our model portfolio and monthly L/S focus list), it is unlikely you will be hurt by much. There is a good chance that even if you do not beat some benchmark in the near-term, you will still directionally benefit in some way.

Disclosure: None

Source: Relative-Value Approach Can Justify Continued Buying