The Shift to Bull Market Thinking Has Begun

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Includes: DIA, SPY
by: John Tobey, CFA

In January I wrote, “Be Contrarian; Believe a 'Real' Bull Market Is Starting.” It looks like it’s begun.

There are still reports using “but” to offset good news, and The Economist is still happily pointing out where the rain is falling or could fall. However, the continuing economic and financial improvements are forcing a shift in thinking.

The economy keeps on trucking, only a bit faster now

Remember the warnings that if the U.S. grew, it would be slowly? Not only is double-dip gone, so is the vision of muddling along. According to The Kiplinger Letter of February 2011:

There’s no longer much reason to doubt it: The economy is shifting into higher gear, with the GDP on course to grow around 3.5% in 2011 … up from a pace of 2.9% last year … and allayed fears that the weak recovery could revert to recession.

Investors have disengaged their investing activity from mega/global problems.
In my January article, I wrote:

What’s important is that investor reactions to 2011 Egypt will not be a re-run of 2010 Greece. Not because the facts are different, but because investors learned last year that most sky-is-falling projections are unrealistic.

This belief was echoed in this week’s Barron’s:

Consider the list of known negatives that have been discounted, and cast aside: rising oil prices; political unrest in the Middle East; crazy weather patterns that could hurt the hedge-fund-heavy retail sector; a new military action in Libya plus old wars in Afghanistan and Iraq.

Don't forget Japan's nuclear disaster; concerns about the global supply chain; currency-market turmoil; the latest woes in Portugal, which are exacerbating the festering sore that is the European sovereign-debt crisis; dismal U.S. new-home sales data; and the sharp rise and fall of the world's most famous investment stock-market risk barometer, the Chicago Board Options Exchange's Volatility Index (VIX).

And now the icing on the cake: Investors are moving to stocks
As The Wall Street Journal reported:

Money managers and advisers say there has been a steady undercurrent of cash heading out of bonds and into equities.

Driving this trend has been increased confidence that the U.S. economy, while still weak when it comes to housing and job growth, is well on its way to self-sustaining recovery.

That final item is what we’ve been waiting for -- the belief that the U.S. is truly improving. But that’s not all. Investors now have the commitment to forge ahead:

Analysts say investors, tired of earning nothing on their cash, are taking advantage of dips in the stock market to buy. That sentiment has been largely missing since late 2008 amid the drubbing that was handed to many who tried to pick the bottom of that bear ­market.

A note about home sales
Housing remains an area with troubling data. However, it is still too early to know what 2011 has in store. We are only just entering the spring-summer selling season when we will see just what strengths and weaknesses exist. Even as that period arrives, however, an ongoing problem is the weak information we have to deal with. For example:
  • Median pricing is fuzzy because house sales are not comparable.
  • Case-Shiller pricing uses comparable sales, but information is delayed until sales are closed and reported (meaning the January prices just released were for sales in the latter months of 2010).
  • Existing home sales are likewise delayed until closed and reported.
  • New home sales are upon signing of contract, so they are timely, but new houses represent a small, variable proportion of total home sales.
  • Existing home sales (pending) is an attempt to get home sales at the time of contract signing, but it is only an index, not an actual count.
On top of those data issues, we have location differences. Not just region, state, metro-area, city or town. Neighborhoods (e.g., a 2008 development vs. an established area) can have vastly different characteristics.
One way to back into housing’s health is to watch the negative indicators: Foreclosures, shadow inventory, late mortgage payments, etc. With the economy improving, it shouldn’t be surprising to see housing join in this year.
So the “bull market” label for the U.S. stock market could become popular soon. It will be nice to remove the “contrarian” hat and put on the “ride the trend” one.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: Client positions: Long U.S. stocks and U.S. stock funds