This was a summer to frustrate or perhaps discredit any prognosticator, bullish or bearish. I went out on a limb in July, describing the post-April move as still a "correction" and predicting that it would soon end. I gave a couple of qualifiers, suggesting that the S&P 500 needed to take out 1130 (then 1103). It traded to 1129, failing my key level a couple of weeks later and then collapsed to a low of 1040, making my call look rather untimely at best.
Here we are, six weeks later and back to 1110, and I think that my call will prove right: The market should trade to 1229-1250 over the next few months. Of course, we are all familiar with the multitude of reasons it shouldn't go up:
- The housing market is moribund at best
- Federal debt levels are too high
- State and local government debt levels are too high
- Unemployment is too high
- The Consumer is overburdened with debt
- Taxes may increase
- Regulation is likely to increase
- The upcoming elections add uncertainty
Did I leave anything out? If so, I am certain I will hear about it!
I believe that a whole bunch of bad is priced in to stocks. Retail investors, seldom known for excelling at timing the market, have left in droves over the past few months. Was it the LT gains being triggered, a return to "cost" or just fear? It doesn't matter the reason, just that they have piled into "safe" assets of Treasuries and Gold. Good luck with that...
Stocks are cheap in both absolute terms as well as relative to corporate bonds. M&A is picking up. Pensions are underinvested and will struggle with their liabilities, suggesting asset allocation that favors risky assets. Did I mention that M&A is picking up?
If stocks were dangerous, then high-yield bonds wouldn't look like this (click to enlarge):
Also, Baa Spreads wouldn't look like this (click to enlarge) :
It sure doesn't look like folks are worried about getting repaid! Actually, the very fact that spreads are pretty normal despite all-time low Treasury yields is actually improving the fundamentals. Companies are able to extend their maturities and lower their borrowing costs. The risk to equity holders is significantly lower than it was just 2 years ago: Many weaker companies are gone, and those that remain have better balance sheets with longer maturities and less competition. Plus, many of them have more than just our stagnant economy with which to contend. The rest of the world is growing faster.
Everything I have said so far is really just a rehash when I made bullish proclamations near the end of July, so I want to offer another piece of evidence that supports my view: Conservative investors are returning to stocks. A very wise investor (and not just because he uses my services!) shared with me in the past that the stock market will struggle to advance if conservative stocks aren't performing well. If cautious investors are afraid to buy stocks, how can we expect more aggressive ones to want to buy? In the last few weeks, equities have drawn investors. Specifically, look what's doing really well: Utilities, REITs, Consumer Staples (click to enlarge):
Whether it's yield or lack of cyclicality, the point is that these more conservative sectors are nearing their 52-week highs. Take a look at Coca Cola (NYSE:KO), for instance. Another example would be ATT (NYSE:T) and Verizon (NYSE:VZ), both of which are on a tear. The point is that the widows and orpans are buying, and my guess is that the rest of the market will follow: Low valuations, diminished expectations, and bearish sentiment.
What am I doing about all of this? Not much. I remain fully invested in stocks (at the 75% max compared to the 60% "neutral") for the Conservative Growth/Balanced Model Portfolio. We have added exposure to Consumer Discretionary lately and are at just 10% bonds (compared to the 40% benchmark). The Top 20 Model Portfolio remains overweight Small-Cap. I am pushing my favorite idea to the max: Cyclicals with low valuations relative to their tangible book values and strong balance sheets. I published a list of 150+ names that meet several criteria, a few of which are included in that model. In fact, 6 of our 20 slots are represented by this theme. If you peruse the list for ideas, please feel free to share any feedback you might have.
So, today I am repeating my bullish outlook, but this time without qualification. Frankly, it's not a bold call. After all, a move to the high-end of the range I provided of 1229-1250 is just 12.5%. It's not that big of a deal - unless you are sitting in cash at less than 0.5% or are betting against it.
Disclosure: Long KO in Conservative Growth/Balanced model portfolio at Invest By Model