After a couple of brief encounters with the bear camp’s best arguments in August, traders have leaned long lately and appear to have once again embraced the glass-is-half-full view for the past week and a half. Although it was a holiday-shortened adventure, the bulls have to be pleased with the fact that they were able to push all of the major indices to new cycle highs last week before seeing a little profit-taking on Friday.

The move higher in stocks over the past 6 sessions seems to fly in the face of the expectations from the bear came and the overly negative seasonality. Anyone who has ever heard of the Stock Trader’s Almanac knows that September is supposed to be a really crummy month for stocks. And while it is true that the transition month from summer to fall has not been kind to stock prices in the past, the action leading into the month actually has had a lot to do with the outcome.

As we’ve mentioned recently, history shows that if the first eight months of the year produce gains of 10% or more for the S&P 500, the month of September winds up being a pleasant experience as the market sees gains of about +0.5% on average. While this is not a spectacular return for a 30-day period, it is also definitely not a result worthy of fear and loathing. No, it is when the S&P is up less than 10% during the first eight months of the year that the bulls tend to be treated badly in Septembers.

So far at least, this historical pattern has played out as the S&P 500 finds itself up +2.17% for the month investors have been taught to dread, while the Dow sports a gain of +1.15%, the NASDAQ is up +3.58%, and the Russell 2000 has enjoyed an advance of +3.76%. Not bad. Not bad at all.

Why the Turnaround?

The primary reason for the bulls’ recent return to prominence hasn’t been a single economic report or a big pronouncement from an influential analyst. In short, the biggest driver of the recent gains has been the favorable start to the pre-announcement season. If you are not familiar with the concept, this is the period of time leading up to earnings season where companies let everyone know how they are doing relative to the “earnings guidance” they provided at the beginning of the quarter. Also known as the mid-quarter update, the idea is for companies to try to remove any “big surprises” from the upcoming earnings season.

The trick at this stage of the game for investors is to keep their ears to the ground for the message coming out of the pre-announcement period. And so far at least, that message has been pretty good as some big names such as Intel (INTC) and Texas Instruments (TXN) have increased their guidance for the quarter’s earnings and had good things to say about the overall environment.

To be sure, this is a tedious task as it is quite easy to become bogged down with the details of each company’s forecast. And we understand that most investors have neither the time nor the interest in reviewing a vast array of company reports. But again, the idea isn’t to become an expert in each company (that’s what the analysts are for) but rather to try and glean the overall “message” from the companies that are reporting.

Last week, that message was fairly upbeat, especially in the chip sector as we saw a batch of positive pre-announcements for the September-end quarter from the likes of Altera (ALTR), ASML Holdings (ASML), Atheros Communications (ATHR), Diodes (DIOD), Microchip Technology (MCHP), RF Micro Devices (RFMD), Skyworks Solutions (SWKS), Texas Instruments (TXN), and Volterra Semiconductor (VLTR). And while these are not all household names, the message from their pre-announcements was clear: Things are not as bad as the bears would have you believe.

But the upbeat message wasn’t limited to the chips. Although consumer staples stocks underperformed the broader market this past week, Procter & Gamble (PG) said that organic sales will rise between 1% and 4% in fiscal second quarter, while General Mills (GIS) noted that its current estimate for the quarter is exceeding their own internal targets. And then in the retail space, Urban Outfitters (URBN) said that their sales comparisons were in line with estimates, Staples (SPLS) said that it is seeing a sustained improvement in same-store sales, and Office Depot (ODP) noted that back-to-school results seem to be a bit better than what it has seen in previous quarters. And finally, FedEx (FDX) put some icing on the cake as the company raised its fiscal Q1 earnings guidance.

So, while it may have been tough to find a headline grabbing reason for the recent steady march higher and the distinct lack of a battle when the indices plowed through important resistance levels last week, if you keep your eyes and ears open and understand what is driving the action, the “reason” for the advance makes perfect sense.

More To Come?

Does this mean that our heroes in horns have embarked on a new leg higher and that without any serious resistance overhead stocks will march merrily higher to the 1200 level on the S&P? Our answers would be “most likely” and “no.”

While it does appear that the bulls are busy discounting the likelihood of another earnings season that could be better than expected, this does not mean that we won’t see any corrective action between now and the end of the year. Remember, at this stage of the game, the economic recovery remains fairly fragile and there is bound to be negative inputs that crop up from time to time that scare the heck out of investors.

However, let’s not forget that analysts have spent the better part of the last year hacking into the earnings estimates for the companies they follow. And since the game is all about reality versus expectations, it is beginning to like there is a good chance that corporate America may be able to sail over the very low bar that has been set for the upcoming two quarters.

What does this all mean for our investment strategy going forward? It means that the chances for additional upside are fairly good but that as we’ve mentioned recently, the rate of ascent is likely to slow going forward. It means that unless we see a change in the fundamental picture, corrections are likely to continue to be short and shallow. And it means that we should be looking to buy the dips a while longer.

However, we would be remiss if we did not include the important caveat that this is no time to get complacent and that this remains a secular bear market environment. So, we will attempt to enjoy the fun while it lasts and then get the heck out of the way.

Wishing you all the best for a profitable week ahead,

David D. Moenning
Founder TopStockPortfolios.com

Positions in Stocks Mentioned: None

 

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