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OTC Journal Members:
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The Bullish
Case - "Cash Is Trash" Fuels The Market For Now |
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The stock market is in a good solid
uptrend. It is undeniable. Even the staunchest of Bears has gone into hibernation.
71% of market pundits are bullish at this time (normally a good contrary
indicator). Traders are being blown out of put options left and right (myself
included), and short sellers have gotten their brains beat out in this
incredibly persistent rally which began in Mid March.
This chart of the S&P 500 shows
the long term technical picture. I have included two very simple technical
indicators. The Red Line is the long
term resistance trend line drawn from the October high in 2000; the point
at which the Bear sunk his teeth into investors. For the past three years,
every time the market tried to get through this resistance line it was
repelled.- Until Now In early May the S&P 500 finally
broke through the downtrend line convincingly, forcing many technicians
to reevaluate their bearish stance.
The Yellow
Line represents the simple 200 day moving average. This line
is considered a benchmark for the long term health of the market. Indexes
trading above their 200 day moving averages are considered in an uptrend.
The S&P 500 solidly breached the 200 day moving average several weeks
before the long term downtrend line was pierced.
All in all- This is a very bullish
chart.
Yet despite mounting technical evidence
that we are back in a bull market, economic results are anemic at best.
So what's fueling this exciting rally?- Liquidity- cash looking for a return.
Do you know just how much fuel is looking for a fire?
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According to TrimTabs, a record $5.3
trillion in cash is sitting on the sidelines (savings accounts,
CDs, money market funds, etc.). This amount is equivalent to 51% of the
value of the entire US stock market. The last time the cash-to-market ratio
was this high was 1990, when the cash-to-market cap ratio stood at 49.5%.
The S&P 500 moved 30% higher the following year.
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The Fed has pushed interest rates to
40 year lows- Interest rates haven't been this low since the Eisenhower
administration. If you have your money in a CD or money market account,
after factoring in taxes and inflation, you are losing money (about 1.5%
annually; hence- cash is trash).
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Mutual fund inflows picked up dramatically
in June- $3 billion flowed into equity funds the week ending June 4. $5
billion flowed in the next week after a month of outflows in May.
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Under funded pension plans must be reloaded,
and the money has to go somewhere. Trillions will flow into the markets
as major corporations reload their pension plans and invest the capital.
Over the past three years our economy
has absorbed four serious body blows which might have crippled a lesser
fighter. The US economy is definitely the Mohammed Ali of the world's economies.
Like Ali in 1974 against George Foreman in the "Rumble in the Jungle",
the US economy seems to be able to withstand devastating blows and come
back fighting.
The tech bubble burst, followed by
911, followed by Enronitis, followed by war with Iraq. Yet, despite these
potentially devastating events, we are still cruising along at a moderate
2% annual GDP growth rate with no inflation. Is it possible our economy
is stronger than anyone realizes? Could our economy come back and win the
fight in the 8th round the same way Ali beat the larger, stronger, and
heavily favored George Foreman?
The recent rebound in the market
is a liquidity rally- fueled simply by demand outstripping supply. So-
without top and bottom line growth- can the rally continue?
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Hold
The Phone- Did S&P Earnings Rocket In the First Quarter? |
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Here's a bar chart of S&P 500
reported quarterly earnings. These are earnings net of one time charges,
and generally the earnings which appear in tax returns.
Reported S&P quarterly earnings
challenged the $14 level during 2000, then fell off a cliff into mid 2002.
We had a brief rebound, only to end at an incredibly low $3.00 in the December
2002 quarter.
What the heck happened in the March
quarter of 2003? Could S&P earnings really have rebounded from $3 to
$11.91 in just one brief quarter?
The answer is Sort Of.
As we have chronicled in past editions, many companies used the bear market
environment as an opportunity to rid the financial statements of dead wood.
Companies aggressively wrote down inventories, accelerated depreciation,
absorbed costs associated with layoffs, and became lean mean during the
Bear Market when share price was not a consideration. This "purging" of
financial statements peaked in the fourth quarter of last year in conjunction
with setting the bear market low this past October.
The net result- a moderate top line
increase of about 5% yielded $11.91 in reported quarterly earnings for
the S&P 500- on the surface an outstanding rebound.
The numbers are misleading and exaggerated
but serve to illustrate the point. Companies are lean and mean. The gap
between reportable earnings and operational earnings will be very narrow
for some time. Incrementally small increases in the top line can lead to
disproportionately positive bottom line increases for companies with 3%
body fat.
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Where
To From Here? |
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In this "Hope and Faith" rally, the
market may have charged up a bit too far too fast. Nearly everyone agrees
a correction would be healthy right now. If the market extends too far
the inevitable correction will be too violent, sending investors fleeing
to the exits once again.
This liquidity rally has limits.
In order for the Bull to continue to rage, we need growth; growth in both
the top and bottom line.
In order to buy into the concept
of a sustained bull market, you must be willing to believe that fiscal
stimulus will work. You must believe low interest rates will force investment,
which will foster growth. You must believe the tax cut package will put
a surge of liquidity into the economy. You must hope the worst of geopolitical
events are behind us. You must believe 3% to 3.5% GDP growth will come
back, and bring job growth with it.
For those who want to wait for top
and bottom line growth before getting back into the market you might want
to consider the following:
The Market is generally a leading
indicator, not a lagging indicator. Today's market direction tells us where
we will be in six months. After all- the market got slaughtered in 2000,
six months ahead of a 35% drop in S&P earnings, and continued down
for the next three years. If the market had it right then, why can't it
be right now?
I'm sure about one thing- As always,
with the stock market there are no guarantees. But if you wait for the
economic numbers and earnings to confirm the turnaround, you'll miss most
of it.
Charts Provided Courtesy
Of TradePortal.com |
