Brace yourselves dear readers because what we are about to explore is unabashedly positive. However, before we begin, we must offer the following caveat: A list of positives does not the start of a new bull market make.
For those of you that prefer the bottom line first, here goes. We believe that the stock market is setting up for a decent and quite possibly, a very tradable rally. But while we have a fair amount of evidence to back up our case, we do NOT have any indications that a new bull market is underway. In fact, we do NOT have any indications that we’ve seen the ultimate lows of this bear market.
But, but, but… it is important to understand that even during the grizzliest of times, significant rallies can and DO occur. And for those of us that manage money in the stock market, these are the types of moves that we want to be in position to benefit from.
So, with the appropriate disclaimers in place, let’s get to the reasons why we are leaning positive right now.
The Tone Has Improved
As we’ve been saying lately, the tone of the market has improved over that past three weeks. As evidence we offer the following. First, we’ve seen only one scary plunge since the November 20th. And for those of you keeping score at home that means we’ve gone fifteen trading days with only one day that required the helmet and the fetal position under the desk.
Next, we offer the term ‘resiliency.’ Yes, we recognize that this is really a subset of our first argument. However, this word is being used more and more these days as stocks have been able to avoid falling in the wake of bad news. And in the case of the December Jobs Report, the indices actually advanced after getting word that the economy had lost more jobs than at any time in a generation.
Finally, don’t look now, but the major indices have effectively been going sideways (albeit in a rather violent fashion) for more than two months now. Thus, if one were so inclined, the argument could be made that we are in the midst of a basing process.
A Big Signal Goes Green
One of the things we wanted to see happen before turning more constructive on the stock market was a “breadth surge buy signal.” This signal “goes green” when the 10-day total of advancing stocks (and remember, we use an index of the 1500 biggest and most liquid stocks traded in the U.S. here and NOT the NYSE advance/decline data that is skewed by the vast number of non-operating company issues) is 1.9 times greater than the 10-day total of declining issues.
The key to this indicator is whenever the number of advancing issues swamps the number of decliners over a two week period, it is usually an indication that something good is happening in the market. Another important aspect of the breadth surge buy signal is it doesn’t happen very often. For example, the signal on December 5th was only the 29th such buy signal since 1947 (and 9 of these signals actually could be considered duplicate signals. For example, there were a total of 3 buy signals given in 2003).
It is also important to note that of the 28 previous signals, the market has been higher one year later 27 times. (The lone “bad signal” over the 12 months time frame occurred in January 1987.) The average gain on the S&P 500 one year after the signal occurred has been +17.2%, which is almost double the average return for all 252 trading day periods.
The signal hasn’t been too bad in the near-term either. According to the computers at Ned Davis Research, one month later, the S&P has been higher 23 out of 28 times (a batting average of .821) and sported an average return of +3.4% (the average return for all 22-day periods is +0.7%). Three months later, the signal sports the same batting average and an average gain of +7.2% versus the normal 63-day return of +2.0%. And just to complete the look-back at history, six months after the signal, the S&P has been higher 25 out of 28 times and sported an average gain of +12.4%, which was a hair more than triple the average (4.1%).
So, given that this signal doesn’t happen very often and has been a solid performer in the past, we will want to recognize it by, at the very least, giving the bulls the benefit of the doubt for a while.
Extreme Readings
Another reason to lean positive – at least for a trade – is the extreme readings seen in anything relating to investor sentiment. Go ahead; ask anybody you bump into on the street why the stock market is going down. We are fairly confident that at least 8 out of 10 people will be able to rattle off the market’s problems and they might be even be able to tell you how much they’ve lost in their 401(k) plan. (The average cited at my lunchtime discussion on Friday was -46%).
Moving on to evidence that is a shade less anecdotal, all of the sentiment gauges we watch have fallen into zones only seen during the depths of bear markets. In short, this tells us that the vast majority of people who wanted to sell have already done so.
However, the absolute best piece of evidence in this area comes from the recent T-Bill auctions. In short, institutional investors are so desperate to show “cash” on their books at the end of the year, that they were willing to accept 0% on the T-Bills they bought for the next 4 weeks. And in an extreme head-scratcher, some investors were even willing to LOSE money on their purchase of three-month T-Bills last week. I guess the thinking here is that losing a little money, by paying more than par for the bills, was better than the potential loss they were expecting in other vehicles. Can you say “negative sentiment?”
And the Rest of the List
In light of the fact that we really did not set out to pen a novel this morning, we’re going to bullet-point the rest of the list so that you get back to your day in a timely fashion:
- Massive Stimulus: Lest we forget, the governments of the world are going out of their way to spend a boatload of money in order to (a) bailout their banks, brokerage firms, etc. and (b) to get their economies moving forward. So, as they say, don’t fight the guys who can print the money!
- Enough is Enough: We’ve mentioned this a time or three lately, but it is important to recognize that the financial system did NOT fail. Thus, the “discounting” the stock market is currently doing now applies to the outlook for the economy. In short, the decline
