Why U.S. Stocks Can Move Higher in 2007 - Part I

Includes: IYY, SPY
by: Jeff Miller

It is our conclusion that stocks can move much higher during 2007. This is no surprise to regular readers of "A Dash," but it is a good time to summarize the current situation. We will do this in a multi-part series examining several issues.

This installment considers an overview of basic considerations.

Psychology and Sentiment
Over the last few weeks we have noted a changed attitude among many active traders and fund managers who state public positions. We started to note these, planning to cite links, but decided against it. It is so pervasive that it seems unnecessary. Everyone is "taking something off the table" and trying to lock in gains, nervous about the seemingly relentless advance.

The TickerSense blogger sentiment poll captures this quite well, with over 40% bears and 25% neutral. It seems unusual for bearishness to be rising with the market.

One reason is that the bullish forecasters are seeing the market approach their original expectations for the year. Revisions to forecasts are modest. Abby Joseph Cohen is going to 1600 on the S&P for 2007. That puts her on the bullish extreme, but it is only about 6%. Ed Keon, whom we have cited in the past for his excellent analysis of market factors, remains the biggest bull with his forecast going to 1650.

Meanwhile, there are plenty of forecasts of a major blow for stocks. Traders are reacting to perceived risk and reward. That is how psychology works.

There is a lot of rhetoric about a "melt-up" or "ignoring the fundamentals." Since we believe in analysis rather than rhetoric, it is necessary to look at technical and fundamental considerations.

Technical Indicators
Before accepting the "melt-up" talk, it is useful to look at a chart. We recommend today's excellent analysis by TraderMike. We see in his charts some strong trending markets, but nothing parabolic. Many active traders follow Worden, where today's indicators show uptrends in every time frame they follow (subscription required).

Some technicians report "overbought" conditions. It would take a very small pull back to relieve these overbought readings. Moreover, overbought trending markets can move higher -- much higher.

Most importantly, our own technical models, devised by Vince Castelli, caught the end of last year and the current move. They remain bullish on all of the major indices, a position that (unlike many others) we have reported contemporaneously on TickerSense.

Some assert that the market has gotten ahead of fundamentals, since stocks have advanced more than recent earnings growth. These analysts are focused on what we call "local efficiency." They are assuming that last year's pricing was an accurate valuation.

In fact, stocks have lagged during a multi-year period where profits grew at double-digit rates.

There is a lot of catching up to do.

Our own preview of 2007 informed investors that market valuations were low when one took the current low interest rates into consideration. Those who ignore interest rates in their analysis of fundamentals are adopting a method that we find distinctly inferior.

We have explained why this is true. Articles in this series will show how it is playing out before our eyes.

There are also plenty of miscellaneous arguments lacking evidence. Our favorite radio commentators on Car Talk have a term for such claims concerning car repairs. They call them "BOGUSSSSS." We will try to identify and discuss several instances including the following:

• "Peak" earnings
• Ignoring interest rates
• The market record of umpteen up days and the need for balance
• Stock buybacks as "inferior" earnings
• Poor recession forecasting
• Earnings mean reversion

Our work is laid out and our position is clear. Obviously, the stock market can decline at any time for many different reasons. Our technical models can change our trading positions, and we shall report if that happens.

These would be short-term factors. Our fundamental conclusion is that stocks have plenty of room to run. We remain leveraged up in trading accounts and close to full investment in individual accounts.