Bull Market Continues, But Will Cash Be Summertime King?

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 |  Includes: DIA, QQQ, SPY
by: Sy Harding

Summary

Increasing similarities to 2011, in the current economy, investor sentiment, valuation levels, and the Fed’s situation, are not encouraging.

The S&P 500 plunged 19% in 2011 before the Fed realized what was happening.

The Fed rushed in with additional QE stimulus that prevented the significant correction from worsening into a bear market.

Is it that enough positive economic reports are shining through the preponderance of dismal reports to keep the market's spirits up? Or is it that irrational exuberance has reached the stage where the market has stopped looking at reality and believes only what it wants to believe?

I ask because there have been significant surprises in both directions over recent months, and the market has had almost no reaction to any of them. It began with the positive surprise of the employment report showing 288,000 new jobs created in April. The market had almost no reaction.

There was the negative surprise of the initial report that GDP growth slowed to only 0.1% in the 1st quarter. Again no reaction by the market.

The lack of interest continued through reports since, from the housing industry, retail sales, durable goods orders, and so on, some positive, some negative.

This week the market completely ignored the shocking downward revision of 1st quarter GDP to negative -1.0%, as well as the report that pending home sales were up only 0.4% in April, and that consumer spending and consumer sentiment both fell in May.

Instead, the market calmly broke out of its five-month long sideways funk to the upside.

Bank of America/Merrill Lynch (NYSE:BAC) came out with a forecast yesterday that the breakout could continue for a while, citing a large build-up in short-sale positions by speculators that could be forced to the buy side on any further upside break-out, adding fuel to the rally. The firm's analysts noted short-term support is also likely from the European Central Bank's meeting next week, when it's expected to take additional easing measures to boost the still anemic and struggling eurozone economies.

BAC/Merrill Lynch analysts expect ECB action will mostly benefit emerging markets and struggling European markets.

If you want to follow that thought, you might want to consider the VanGuard All-World ex-U.S. ETF (NYSEARCA:VEU). It's designed to track with the performance of the FTSE/All-World ex-U.S. Index, consisting of companies in developed and emerging markets around the world, but excluding the U.S. market. Like the U.S. market, it recently broke out of its sideways trading range to the upside.

However, realize that it would not be a safe haven in the event of a correction in the U.S. market, which would quite likely carry global markets down with it. And the other side of the BAC/Merrill Lynch good news/bad news forecast is that, "We stick with the view that a summer melt-up would likely be followed by a nasty correction in the autumn."

Still others are not as optimistic for even the short-term.

Says Comstock Partners: "Despite the new highs, it seems to us that the stock market is running out of steam."

Meanwhile, current economic and market conditions, as well as the Fed's QE situation, are eerily similar to 2011.

In the spring of 2011, the Fed's QE2 program was due to expire in June, and the economy had already been slowing in the winter months. In April 2011, it was reported that GDP was negative in the 1st quarter. The stock market soon topped out and by the time the Fed reacted and rushed in to extend its QE stimulus, the S&P 500 was down 19%.

In the spring of 2014, the Fed is tapering back its QE stimulus, already half of what it was in December. The economy already slowed in the winter months before the tapering began. Now we have the similar report that GDP was negative in the 1st quarter.

In my newsletter issue in April 2011, I noted investors' bullishness and complacency. The Investors Intelligence Sentiment Survey was at 57.3% bulls, only 15.7% bears. It is currently at 58.3% bulls, only 17.3% bears. I noted in April 2011 that the VIX Index (aka The Fear Index) was at a low of 16, showing virtually no fear. It is currently even lower, under 12.

On valuation, I noted in the spring of 2011 that the S&P 500 P/E ratio was only 16.2, but the Shiller CAPE10 P/E ratio was 23.5. Currently, the S&P 500 P/E ratio is 19.2, and the Shiller CAPE 10 is at 25.9.

In 2011, the Fed was still concerned about the anemic economy and poised to rush in with more QE stimulus. Even so, it made it just in time before the market correction passed the 20% threshold into a bear market.

In 2014, the Fed is determined to continue cutting back its stimulus, confident the recovery can handle it, the dip in recent months just weather-related.

In my mid-April issue in 2011, I said, "The good news is that the market remains remarkably resilient in the face of so many negatives. But fair warning - with the way the negatives are stacking up, seasonality may be even more important than usual this year."

Nothing I am seeing in investor complacency, enthusiasm for IPOs, in the market's resilience, in the economic reports, and now in the similar conditions to 2011, disabuses me of my expectation of a significant correction during the summer months to a low in the October/November timeframe.

That is in spite of bullish assurances from Wall Street and the Fed, similar to those in 2011, that all is well (until it wasn't).

It's not yet time for short-sales or downside positions. However, it is a time to be raising cash for the bargains that will be available later in the year.

In the interest of full disclosure my subscribers and I have taken a position in the VanGuard All-World ex-U.S. ETF (VEU).

Disclosure: I am long VEU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.