We Are Firmly In Stage 2 Of A Bull Market

|
 |  Includes: DIA, IWM, QQQ, SPY
by: Russell Shor

Summary

We are in stage 2 of a bull market.

There may be a pullback, but that is the nature of the market.

Economic fundamentals are good.

Originally published on July 28, 2014

Our model portfolio:

Our model portfolio appreciated by 1.63% for the week, whilst the broader market was largely flat. Since inception, which was around the first week of April 2014, our portfolio has grown by 12.37%. In comparison the S&P 500 has appreciated 8.94%. This is an outperformance of around 3.4%. Please note the stop loss of Facebook (NASDAQ:FB) has been raised to $60.15 as per yellow highlight.

We have maintained a bullish stance and continue to do so. There are generally 3 phases to any bull market:

  1. The renewed confidence stage.
  2. The improved earning stage.
  3. The rampant speculation stage.

We are of the opinion that we are firmly in stage 2, an assertion that we made in our blog post titled "VIX at lows" around 6 June. This stage tends to be the longest and most stable of all bull market phases. Second quarter earnings by and large have been stellar and we believe it to be some time before the speculative stage of the bull market ensues. Our proprietary sentiment indicators are not at alarming levels:

Sentiment Models

Our models (the indicators below the index chart) typically tick red when market sentiment runs hot. We are nowhere near the danger levels as indicated by the blue boxed areas. Of note, and to be conceded, severe market pullbacks may ensue without a warning from our sentiment indicators. We refer in particular to the 1998 Asian Crisis where no signal in the sentiment indicators was generated - as per red boxed areas. This was due to the nature of the Asian Crisis which was stealthy but short in effect.

The data out over the week included unemployment claims, released on Thursday. This beat forecasts by some margin coming in at 284k against the forecast of 310k. This is the lowest level since February 2006. This is consistent with the monthly job growth that we are seeing - currently above 200,000.

Furthermore, core durable goods orders as released on Friday were also ahead of forecasts. This is a tremendously important data point and we think a positive trend will begin to emerge from here. Orders increased by 0.7% in June after a 1% decline in May. This data point is a proxy for business investment, an economic variable in which many pundits have expressed disappointment. So whilst the consumer has played his and her role in this economic recovery, business has not.

The improvement in durable goods demand seems to be an indication that business is now coming to the party and it is important that this happens. No economic recovery can be sustained without business investing in it.

Moreover, the US economy is simply growing. Consider:

FRED

Industrial production has steamrolled ahead and is above levels seen pre-global financial crisis.

Dow TheoryClick to enlarge

This expansion is clearly reflected in the Dow Industrials (the top index chart). However, the Dow Transports have risen as well (the bottom index chart), implying that this industrial expansion is being moved and hauled around the economy as demand dictates - and make no mistake the demand is there.

Let's take a look at the S&P 500:

The nature of the market

This chart shows Guppy's multiple moving averages with some slight proprietary tweaks. The idea is that the red averages represent the long term investor and the blue averages representing the short term trader. It is the longer term investor which forms the backbone of the market and will ultimately direct the nature of the market whether it is is of the bull or bear variety. As long as there is good angle and separation here the bull market is safe and will continue.

Yes, we will see a pullback as indicated by the blue boxed areas. When this happens, we will see an uproar and uptick in negative commentary, with pundits claiming that the bubble has burst. Which bubble we ask?

The pullback may be severe but in our opinion should be viewed as temporary. It is the nature of markets - they will zig and zag due to the ebb and flow of the herd's emotional changes as it steadily climbs the wall of worry.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.