Todd Salamone, vice president of research for Cincinnati-based Schaeffer's Research, writes Schaeffer's Option Advisor and the Master Portfolio newsletters.
Harlan Levy: Does the labor market look stronger than it actually is, and if so what does it say about the U.S. economy?
Todd Salamone: From what we're seeing, the labor market is improving, which we think will support the economy moving forward. A couple of sectors that we see benefiting from this include the home builders and consumer discretionaries. These are groups that have been the target of the short-sellers and not heavily recommended by sell-side analysts. Yet many equities in these groups have performed admirably.
One of the concerns by analysts has been a high unemployment rate. Yet the data is improving, and the stocks in these groups bottomed well before employment data improved.
H.L.: Is the financial sector strong and getting stronger?
T.S.: It certainly appears so. A couple of weeks ago many companies passed the Federal Reserve's stress tests, which included capital plans such as buybacks and dividend increases. The market is apparently discounting better fundamentals in the future, as many financial stocks' technical backdrops have improved significantly during the past few months.
H.L.: How stuck is the housing sector, and what's your prognosis?
T.S.: Looking at equities in the group, the price action has been extremely strong to the surprise of many analysts and market participants. The price action in the group seem to be indicating improvement in the housing sector. Earnings have been stronger than expected, with the exception of a couple of companies. But overall recent data and recent earnings suggests that housing fundamentals may be better than forecast.
H.L.: How are recent mixed economic data affecting stock market investors?
T.S.: Essentially, there are not a lot of high expectations for the economy. It's mostly getting billed as a very weak recovery. So, as far as stock investments are concerned, unless the data is significantly disappointing, stocks will hold their ground on mildly disappointing data and rally when the data is better than expected.
H.L.: Is the stock market rally sputtering, and will it lose steam this year?
T.S.: It certainly has lost some of its momentum during that past couple of weeks. That said, even though it has lost a little bit of momentum the sideways action has been impressive in light of the fact that many traders have been calling for a correction. However, the technical indicators that they have pointed to as leading causes for a correction are simply indicative of short-term choppiness, according to our own research.
Overall, we think this rally has more life left in it, as there is still a lot of doubters whom we think will play catch-up. Thus, there is a lot of liquidity to support the equity market.
H.L.: What stocks look promising?
There are also some impressive trending equities such as Fastenal and Equinix (EQIX), a digital content and cloud computing company. In fact, EQIX has outperformed Apple in 2012 amid lower daily volatility. Despite this fact, while Apple has experienced a lot of short-covering in 2012, EQIX has experienced a build-up in short interest, which means short-covering could drive EQIX even further in the months ahead.
H.L.: What does you options analysis tell you about the stock market?
T.S.: It appears that a lot of the hedge funds were building up positions earlier this year, but they have since backed up and continued to under-weight the stock market. The fact that hedge fund managers appear to be under-weight is yet another bullish factor if the market does not experience a technical breakdown.
In the event of a pullback, we anticipate hedge fund managers to deploy cash to the market, which will be supportive, and at some point, if the market does not correct, this will be a group that will have to be in catch-up mode.