Stop Fearing Locusts Because The Market May Be Ready To Rebound

|
Includes: JPM, MDY, SPY, WFC
by: Todd Campbell

There are plenty of reasons to dislike (hate?) this market right now. So, instead of re-hashing those, let's take a look at some encouraging, or dare I say good, reasons the market may treat investors better in the coming months.

  1. Sentiment is bad. And, bad sentiment may just be enough to make smart money get a bit more interested in buying stocks on sale. One of the ways I look at valuation is by comparing the future price to earnings ratio ("P/E") against the five year historical P/E ratio low. In April, the average big cap stock was trading 1.85 times its five year P/E low. Last week, the reading was 1.74 times. Today, the reading is 1.55 times. Stocks are getting cheaper. The question remains, however, will next year estimates fall faster than stock prices? If so, the relative "cheapness" of this tape may become less enticing. Regardless, for now we'll argue valuation isn't what is sending stocks lower, it's fear. And, fear is often an indicator of opportunity.
  2. Insiders may be telling us business isn't as bad as we fear. Across over 500 big cap stocks, 86 have had some form or recent insider buying activity. Last week, there were 80. The numbers are similar for mid and small cap names too. In mid cap, 72 stocks have had recent insider buying activity, up from 42 the prior week. And, in small cap, 116 stocks have had recent insider buying activity, up from 79 the week before. If insiders are willing to put their money on the line, perhaps we should be too.
  3. Short sellers are too happy. Across more than 1800 institutional quality stocks (those with average daily volume, sales and market caps big enough to entice big money), short interest is up across the board since March. Shorts are particularly aggressive in technology and services, which suggest, any tide turning, may shift short sellers from pressing bets to reining in risk. If that's the case, with nearly 13 days of average volume to cover short in small cap financials alone, stocks could trade up.
  4. Cooler weather means cooler heads prevail. Fall is a much better time for stocks, historically, than summer. How much better? The S&P 500 ETF (NYSEARCA:SPY) has finished the 3-month period starting September and ending November higher in 9 of the past 10 years. That's pretty compelling. Especially when we consider the SPY has finished the 3 month period beginning June and ending August higher only 4 of the past 10 years. Its even more dramatic for the S&P 400 Mid Cap ETF (NYSEARCA:MDY), which finish the 3 month period ending November 8 times higher, after finishing the 3 month period ending August only 3 times higher over the past 10 years. Since sell in May worked nicely again this year, the reverse holds true investors may find tailwinds supporting returns by Thanksgiving.
  5. Banks may be facing eroding net interest margin on a flattening yield curve, but it hasn't stopped them from lending to businesses. In July, commercial and industrial loans at commercial banks rose to $1264.7 billion, the 9th consecutive month of expansion. Such loans totaled $1204.4 in October 2010 and the trend has continued into August. In the week ending August 10th, C&I loans at our biggest banks climbed to $661.5 billion, up from $657.8 billion the prior week. This is nicely above the $647.7 billion in mid July and means stocks like JP Morgan (NYSE:JPM) and Wells Fargo (NYSE:WFC) may be seeing more demand than the market is anticipating.
  6. Retail sales, the truest indicator of our consumption driven economy, are coming out of summer and that's good news. Just how seasonal are retail sales? In the past five years September retail sales (including motor vehicle and food service) fall -7.58% on average from August. In Q4, however, retail sales bounced back through year end, kicking off with an average 2.4% increase in October from September. Over the past 10 years, the Retail Holders Trust (NYSEARCA:RTH) has finished August higher than it starts June only 3 times. But, in the coming period starting September and ending November, the RTH has finished up 7 of the past 10 years.

So, while there are plenty of reasons to be bearish, and plenty of people discussing them, there are reasons to be buying. If you don't believe financial Armageddon 2.0 is upon us, weakness in September may be just the chance to get stocks on sale before upside into the year's end.

Disclosure: I am long JPM, WFC.