With 18 Grammys, the Queen of Soul, Detroiter Aretha Franklin has certainly earned the respect of millions over a fifty-year career in show business.
Conversely, despite six advancing weeks in a row, the latest bull rally just can’t get any of that R-E-S-P-E-C-T. Although the stock market averages have either topped their four-month-old high water mark (as is the case with the Dow Jones Industrial Average), or they are just shy of that top (the S&P 500 closed Friday just four points or 0.3% from a breakout), the chart below demonstrates that the average investor just has not bought into the bullish case.
In fact, the chart also demonstrates that the level of investment sentiment is more consistent with a market bottom than a market top.
“I’m about to give you all of my money
And all I’m askin’ in return, honey
Is to give me my profits
When you get home”
So maybe it’s the earnings reporting season that just concluded that worries investors. The second quarter was a bit disappointing. Only 58.7% of the reporting companies beat the estimates of the analysts, and only 48.4% of the top line, revenues of the reporting companies beat. Both rates are the lowest since the current bull market rally began in March of 2009.
Still, among S&P 500 companies, 68.6% of companies beat their projected earnings, and the market seemed to respond, as prices headed 5% higher during the reporting which began July 10th. Furthermore, while revisions in estimates were more negative than positive at both the beginning and end of the period, they were less negative at the end (-18.4 vs. -29.4%).
While it’s possible that the disappointing second quarter may set up a robust third quarter, early indications are to the contrary. StreetAccount.com, which synthesizes information available in the financial markets, reports that, “The Street is currently looking for S&P 500 EPS to decline 2.9% year over year in Q3, down from expectations for 1.7% growth previously.”
At the same time, although interest rates are very low, rates have turned substantially higher. While higher interest rates are normally bad for the stock market, it has been my experience that early on, the rise in rates can signal better times ahead, and actually spur stocks higher.
Both earnings and interest rates are greatly influenced by expectations about the economy. As bad as things looked back in June, they have improved a bit lately. Last week there were seventeen economic reports posted and we grade eleven of them as bettering the projections of the economic experts.
Consumer expectations, retail sales, and housing permits have all topped expectations. And inflation was reported flat as opposed to the expected slight increase. Better-than-expected economic numbers in a low inflation environment can spur further gains in the stock market.
Political seasonality continues to provide support for the rally as well. Until the first week in September, the stock market in election years has tended to move higher. That creates positive vibes for another three weeks. Like our own Political Seasonality Index, look how well just the election cycle portion has foreshadowed the stock market index moves this year.
Of course, as any market watcher will tell you, there are plenty of reasons for stocks to turn lower. The near breakout may only reflect the reaching of a resistance point set by the old highs. Volume, the numbers of advancing and declining issues, and small-cap index values have all failed to confirm the market’s move back to the old highs. These divergences are worrisome.
Also, many of the bears are citing the low level of the “Fear Index,” the VIX, as another good reason why stocks should tumble. Our research does not confirm these fears. While stocks do tend to fall when the VIX is low and complacency is high, we have had plenty of low volatility (VIX) rallies. In fact, our research suggests that it is the change in direction from a low to a high volatility environment that concerns the market, not the level of the volatility readings.
Our Targeted Volatility Analysis (TVA), used in many of our active strategies, actually increases its use of leverage when below-average volatility conditions exist. Conversely, when volatility starts to move higher, leverage is eliminated and eventually hedges to reduce expected future volatility are put in place.
As a result, running TVA on both the S&P 500 Index and the NASDAQ 100 suggests that a 100% invested to leveraged position is currently appropriate.
So while most of Wall Street sits in cash or, worse, bonds (which have been falling in value), many of our equity strategies are fully invested. Check out Market Leaders, STF, Classic and PSI. They’ve had us 100% in stocks as the market has moved higher. For this rally, we’ve had nothing but:
Take care, TCB
All the best,
Election Year Update:
RealClearPolitics two-week average: Obama +2.8%
Average of Likely Voter polls: Tie
On this date in 2008: Obama +7.6%
On this date in 2004: Bush +1.5%
14 Battleground State Polls:
RealClearPolitics two-week average: 10 Obama/4 Romney
Last State poll: 7 Obama/7 Romney
Improving over average poll: 9 Romney/5 Obama