Which way from here?

[A9suited]

Where are the US equity markets headed over the next 3 months? I have an opinion (see it below) but good arguments could sway this.

My opinion is that the recent ramp-up is a bear market rally, based on the following:

-minimal hard data that economy is expanding
-continuing decay of employment
-high levels of investor bullishness
-equity prices are generally high
-softening US dollar and rapid rise in 10 yr Japanese bond yield will add pressure to US long term rates
-housing boom has likely peaked or will soon

This recession was caused by over-investment rather then increased interest rates, and the current rally flies in the face of it.

I am aware that some of the points detailed above are 'backward looking' indicators, and easily rebutted from this perspective, but I would appreciate anyone with comments supporting a continued stock market rally to weigh in. (shooting down my points is not adequate to convince me the rally will continue)

A9s

[Aragorn]

FWIW, I don't see a clear direction for the market right now. That makes the current rally a bit suspect to me, although after a long bear market some kind of rally isn't a huge shock.

Clearly the fundamentals aren't there for a serious bull market.

I tend to agree with Warren Buffet that for most of this decade we should expect the market to average around 5% per year return. I figure you can't go too broke agreeing with Warren Buffet.

[Wildbill]

I think its time to bury the bear market, when the indexes are all up over 20% from their last lows then the bear is probably been put out to pasture for some time. That is not to say there won't be a bit of a pullback as summer and far are usually not all that nice to stocks anyways. I do have to agree though that stocks seem to have gone up a little too fast, but much of that I suspect is inevitable when you can't make anything with bonds or time deposits and many people are starting to use the b-word for real estate. So with those in mind I would guess a modest pullback for the next 3 months would be in order. I think the economy has gotten much stronger and is on much firmer ground, but productivity has been so blockbuster that hiring isn't going to boom right away. To most people the economy is good only when jobs become easier to get. If you hold things to that standard we could be in for a long wait for things to get better. If you just look at standard figures like the GDP and incomes then you will see a pretty healthy economy the next 12 months. Not blockbuster justifying a 30% NASDAQ rise, but healthy with upward potential building. This is the perfect time for small caps to excel and they really have picked it up, but they are still the safest bet. I love the area because big ticket things aren't really what people or businesses are buying with job uncertainties, but solutions to problems and small ticket items are selling quite well due to solid real income growth. Focusing in on those things, items that make life easier or things that help companies be more productive are the types of stocks you want to be in right now. Even better, the job market has thrown a lot of very talented entrepreneurial people out there and these small businesses have a rare crack at them with reasonable price tags. Those that are smart are snapping them up and using their experience to figure out ways to get to middle cap status.

[adios]

Interesting perspective and a good post. Where would you put the dividing line in terms of market capitalization (roughly) between a small cap and a mid cap? For that matter mid cap and large cap?

[Wildbill]

I don't think you even need to do that, I just am saying it would be a good move to look into those lesser followed names, possibly doing a Peter Lynch and focusing on names you see at work or in your everyday life. Everybody sees names in their day to day work that the man on the street has never heard of and the analysts tend to overlook them as well. They just make money year after year and fly under the radar. Those are the companies I would focus on now, especially if they are creative about moving around a bit and getting into new niches or industries. A lot of these little guys are happy with what they make now and have no interest in expanding, but the ones that hit home runs for investors go out and get good talent and then figure out ways to safely reposition the company for a "free" option on a better growing marketplace.

[Aragorn]

>>Even better, the job market has thrown a lot of very talented entrepreneurial people out there and these small businesses have a rare crack at them with reasonable price tags.

That has to be the most optimistic spin on high unemployment I have ever seen.

For another perspective on this see this article from the LA Times. You have to register, but it's a good paper and worth it.

http://www.latimes.com/business/la-fi-petruno13jul13,1,4802490.column?coll=la-headlines-business

[Wildbill]

Page is gone so couldn't read it.

Its not spin, its reality. Just ask anyone that had a business that had no stock options back in the late 90s. Even accounting firms couldn't fill their slots. Now not all of these people are bright, but some are and with no chance to even begin the process with them there was little chance to get quality talent to help a company move forward. Problem for most good entrepreneurs is that they aren't all that business savvy, they have a good idea and maybe a good sense of sales, but most end up going down a wrong path that makes no sense or puts a small company in a spot of too much risk. No guarantees of success, but adding quality business talent to a person strongly tied to an idea and you have the potential for something a lot better than either one without the other. Now its not an endorsement of high unemployment, nor the solution to it, but its just the way the market is now and while it remains this way it behooves many small businesses to consider doing this while hte opportunity is there.

[Javelin]

In my opinion equities are still far too expensive even with 10Y Treasuries at 4.65. If the bond market sell-off continues equities will look hideously overvalued. And i don't like the argument that just because bond yields are low and cash returns zero, equities are a good deal. In the short term i think all this liquidity could reinflate the asset bubble (i think housing is a clear bubble now) but i don't think it offers much value. On the contrary, a sell-off in the bond market could push mortagage rates higher which will in turn bring the housing bubble to a sudden crash and that will definitely be a huge negative for the economy and stocks.

I think there are still too many imbalances in the US economy. The best overall indicator is probably the current account deficit which represents the total net borrowing of the US and it continues to remain at record high levels in spite of the recent decline in the dollar. In an ideal world, Greenspan will be able to work his magic, support the bond markets with deflation fears thereby holding up the housing market and allowing corporates to finish deleveraging and start investing again so they can take over as the engine of growth from an exhausted consumer (who's savings rates are still pitiful). The consumer could then repare their balance sheets reducing their record debt levels and improving the current account balance. All the while, the US still relies heavily on foreign money flowing in and supporting a ballooning federal deficit(soon to be near 500 billion i would say). I think its just like the soft landing a few years ago... fine in theory but in the real world something is bound to go wrong. And i think currently the US dollar, stocks, housing and maybe bonds are all overvalued and household debt levels are very high and unemployment is still rising. If something goes wrong (and i assign a fairly high probability to it) it could get very ugly.

short term, i don't have a strong opinion. I guess people will watch earnings, although i don't think they mean too much at this stage. My guess is all the companies wrote off everything they could post Sep-11th so we could have a large base effect. Then again, they might be much more conservative with their accounting and hence understate earnings... bottom line is i think people are really interseted in Q3, Q4 (when all the bulls are expecting a strong recovery, around 4%+ GDP growth). With all the liquidity being pumped into the system i wouldn't be outright short the stock market but unless you're a stock picker (and i'm not) i don't really see much value (Amazon, Yahoo, Ebay, etc. all trading over 100 PE both trailing and forward!).

And is it just me or does equity vol seem cheap? VIX has been crawling along its lows, maybe buying straddles is a good trade.

[Aragorn]

I agree strongly with most of what you write. I have similar concerns about the debt and deficit. Fortunately, the foreign money shows no sign of drying up.

I disagree about housing being a bubble. I think prices are high, and they will have to come down at some point, but population keeps growing and property close to the major cities remains a scare resource. Here, the only way to add housing is to build out. But the property closer in remains desirable. I don't see a real bubble here.

[Javelin]

oops... did i say 4.65 on 10Y? i meant 3.65 of course but at this rate following Greenspan's testimony maybe i'm just ahead of the market! While the stock markets might interpret Greenspan's comments as bullish for the economy, i think rising bond yields could become a real problem. Fannie Mae reported today that latest mortagage refis are already down 15% and if yields continue to head north this will really cool down the housing market.

Short term, i think bonds will continue to sell-off and the Fed will find it difficult to "talk the bond market" up even if it wanted to. They would probably have to cut rates again and even that may not be enough. I think the bond market's focus will now shift from deflation fears on to other things... maybe growth, maybe equities, maybe the $450bn deficit which will go higher.

[adios]

Long end of yield curve took a "damn good whacking" today. I disagree with your statement about what the current account deficit represents. However, in general your viewpoint seems reasonable and I've read and heard similar takes often over the past 2 weeks. Personally I think short term equities are due for a significant pull back. Too many profits to be taken at this juncture. Then again INTC slightly beat the consensus today so who knows.

[Wildbill]

I don't think the refinancing machine matters too much anymore, if the Fed is right and the economy grows over 3% I think everyone should worry themselves a lot more with inflation than anything else. As for housing, the boom has had its uses and productive run, but really now the economy needs other things to get moving. For that reason I don't think the Fed is going to lower rates much unless it really sees a need to do so. And I think that need becomes less and less each day. After all I thought deflation was what worried everyone not that long ago...