by Louis Basenese, Small Cap and Special Situations Expert
Thursday, April 15, 2010: Issue #1239
Last April, I insulted some people when I wrote a column, suggesting that we were at “the start of a new bull market.”
- Gale W. refused to believe it because “the smartest analyst in the world” – not me – was telling her otherwise.
- Lee S. wished I were right. But he wasn’t willing to bet on it.
- And my favorite responder, Henry P., said, “Basenese must live in a parallel world, but one that is different, one in which delusion replaces reality… people that listen to you are going to be in for a very rude awakening.”
Well Henry, if a 74% rally is a rude awakening, I’ll let Chip from Animal House respond for me: “Thank you, sir! May I have another?”
Bottom line: This time last year, nobody wanted to believe that the fledging rally would continue. Pessimism prevailed. And they were dead wrong.
I believe the same thing is about to happen again…
Déjà Vu All Over Again
Even after 13 months of gains, countless investors still have no faith. They doubt the current bull market is sustainable. So much so, they even refuse to call it a bull market.
According to 249 news headlines over the past month, it’s a “melt-up.” (Melt-up? Could there be a phrase that oozes with more skeptical connotations?)
I’ve also heard it labeled “a cyclical bull market in a secular bear market.” Puh-lease! If a 74% rise for the S&P 500 doesn’t qualify as a full-blown bull market, nothing does.
If you share these doubts, stop kidding yourself. We’re in the midst of an historic bull market. One that’s very likely to continue. And here are seven reasons why…
1. It’s All About the Economy, Stupid!
Forget about a double-dip recession cutting off this rally at the knees. The latest economic data points to a recovery that is real and sustainable.
- Take Warren Buffett’s favorite indicator, for example – railroad freight traffic. It just hit its highest level since November 2008 – up 16.5% in the last week of March.
- Restaurant activity rose to its highest level in 27 months in February, according to the National Restaurant Association.
- The ISM Manufacturing Index touched a six-year high last month.
- New orders for manufactured durable goods increased for the third consecutive month, too.
- Industrial production jumped by a solid 2% in February.
- Last month, chain store retail sales logged their best year-over-year increase since 1999.
True, the unemployment picture still stinks. But it’s a lagging indicator. By the time it improves dramatically, the market will have left you in the dust.
2. The “Sesame Street” Indicator is Bullish
Oscar the Grouch loves trash! So do investors.
Case in point: The stocks that got battered and bruised the most during the market’s downturn are the best-performing ones coming off the bottom. Namely, financial stocks. In fact, most are up by double the amount of the S&P 500, if not more.
Of course, this typically happens in the first leg of a bull market. Junk outperforms high-quality companies. But it’s a well-documented fact that investors eventually start rotating into undervalued, steady performers.
There’s plenty of history to back this theory up, too. That’s exactly what happened after the early 1980s recession, the early 1990s recession and the early 2000 downturn, as well. The fact that it hasn’t happened on this occasion yet, means there’s plenty more upside ahead, as high-quality companies eventually take the baton.
3. Technically Speaking…
Although I favor fundamental analysis over technical analysis, that doesn’t mean I ignore technicals completely. After all, we never want to fight the trend. And technicals point to this rally continuing, too.
Take the advance/decline line, for example. It basically gauges the strength of a rally by measuring how many stocks are participating in it (also referred to as the market’s “breadth”). The line is currently very bullish. The last three times it’s been this bullish – in 1962, 1975 and 1982 – the market kept charging higher, according to Dan Sullivan of The Chartist. All the while, investors doubted the sustainability of the move.
Then there’s the common Wall Street wisdom to “never short a dull market.” In other words, don’t bet on a downturn just because it’s been a while since we had one. The bears would like you to believe that the market is overdue for a downturn, since we’ve gone 27 trading days without a 1% move. Let me put their argument in perspective…
We’re not even close to longest streak on record. Back in 1995, the S&P 500 went almost 100 days without a 1% move. So this “dull” market could keep heading higher for many, many more days.
4. Bring on the Stock Buybacks
Companies are spending the lowest proportion of their money on stock buybacks in almost a decade – 28% of operating profit. At the same time, they’re sitting on record amounts of cash – almost $1 trillion.
The good news is we’ve seen a pick-up in buyback activity in recent months. Mizuho Financial Group expects companies to double their stock repurchases this year – resulting in a total of $235 billion. We’re nowhere near a top, either. In 2007, companies spent almost $600 billion on buybacks.
Remember, buying back shares reduces the number of shares available and increases earnings by share. As a result, stocks often climb higher.
Long story short… the speed of buybacks is accelerating and there’s ample cash available to fuel many more. That definitely points to higher share prices ahead.
5. Stocks Are (Still) Cheap
The S&P 500 currently trades for about 15 times this year’s projected earnings, based on Bloomberg Data. If companies deliver the profits they’re promising, shares will need to rise in order to match the average price-to-earnings ratio of 20.6 since 1992.
Looking at this from another angle, we always tell Invesment U readers that share prices ultimately follow earnings. And with the average analyst in a recent Bloomberg survey calling for a 50% increase in S&P 500 earnings this year, stock prices could easily jump just as high.
6. Life Expectancy
The fact that the current bull market is now one year old is a big deal. The last 13 bull markets that lived that long ending up lasting an average of 4.4 years and returned 153%. This bull is still a baby in comparison.
7. The Herd is Clueless (Again)
We all know it’s bad to follow the herd. And right now, the herd is clueless. The entire time the market’s been heading higher, they’ve been plowing their money into bonds!
The latest data from Morningstar reveals that over 95% of the $377.4 billion flowing into mutual funds last year went into bond funds. Year-to-date money flows are similarly lopsided, with 71% going into bond funds.
Even worse, investors are withdrawing money from stocks to fund this strategy. In February, investors withdrew $3.7 billion from U.S. equity funds, the fifth outflow in six months.
So if you’re selling now, you’re investing right alongside the herd. Bad idea.
Be Invested Or Be Sorry
In the end, if you doubted my prediction last spring and sat on the sidelines, you missed out on a massive rally. Another bout of hesitance could mean missing out on more upside, which would be even more disastrous to your wealth.
So make sure you have some exposure to equities. Just be smart about it. Do these two things…
By doing so, you’ll share in all the upside if I’m right. And if I’m wrong, you’ll limit your losses.
In my mind, that’s a far better proposition than running scared, parking everything in cash and getting paid nothing for it. As the saying goes, “Nothing ventured, nothing gained.”