Can the rally continue?

Good economic news has given the bulls something to cheer about, but bears point to future challenges on the horizon.

By Zacks.com Aug 1, 2013 4:58PM

Image: Arrow Up (© Photodisc/SuperStock)By Sheraz Mian

 

This week's positive jobs and GDP reports have helped improve sentiment a bit, but stocks have overall been moving sideways lately after making new all-time highs some time back. 


To market bulls, this behavior is nothing more than a brief consolidation phase -- that they view as a healthy development, given the rapid gains from the summer lows.


The other side is far less sanguine about what's happening in the market, however, and sees this as a sign of things to come, particularly given the sub-par corporate earnings picture and other macro challenges coming the market's way.


These contrasting views beg the question of where we go from here. And that's my goal in this piece -- to survey the landscape of bullish and bearish arguments, to help you make up your own mind.


Towards the end, I will share a robust investment framework that you can rely on, irrespective of whether you lean more to the bullish side or otherwise.

 

Let's talk about the bull case first:


1) The negatives are already priced in: This means the sum total of all bad or negative news about the U.S. and global economy is already well known and reflected in current prices. It seems quite plausible since questions about the Fed, the U.S. economic outlook, China and the eurozone's future have been around for a while now and are no longer "news" to any market participant.


2) Healthy economic & earnings pictures: The GDP growth rate in Q2 may not be that much, but the better-than-expected reading still shows the economy's resilience. Importantly, the outlook remains constructive, with growth expected to steadily improve from the third quarter onwards. The July ADP provides further evidence that the labor market is healing, which should help offset some of the negative impact from higher interest rates on the housing recovery. The corporate sector is in excellent shape, with total earnings in Q2 on track to reach a new quarterly record and the earnings growth rate expected to ramp up materially in the second half of the year.


3) Central bank 'put': Some questions about the future of the Fed's QE program notwithstanding, the overall monetary policy stance across all the major economies, including the U.S., remains favorable and supportive of the market. What this means is even after the Fed starts 'tapering' the QE program later this year, it will continue to keep short-term interest rates at the current near-zero level for a very long time.

 

Now let's see what the bears have to say in response:


1) Market is pricing a best-case scenario: Market prices reflect consensus expectations, and current consensus expectations for GDP and earnings growth are clearly on the optimistic side. Europe's situation has stabilized a bit, but the region remains in a recession and will likely be a headwind for the global economy for a long time. The situation isn't that much better in China either, where the best-case scenario is a stable economic growth at rates significantly lower than what we saw in the past decade. The rest of the so-called BRICs appear to have hit a wall as well, which is having knock-on effects all over the world. It is way too optimistic to assume that the U.S. economy and corporate sector will remain immune from the negative forces swirling all around.


2) Economic & earnings pictures far from healthy: The U.S. economy is no doubt doing better relative to the rest of the world, but that's nothing more than what the 'cleanest-dirty-shirt' analogy tries to convey. Housing and the labor market are doing better, but GDP growth is unlikely to materially improve from what we have experienced lately. On the earnings front, don't let the optimistic consensus estimates for the second half of the year and beyond distract you from the fact that the overall picture is hardly in good shape. Estimates have started coming down already, but have plenty more room to go. Popular stock market valuation multiples that the bulls never tire of citing as reflective of under- or fair valuation start showing otherwise when more reasonable earnings estimates are used.


3) The Fed Is in a bind:
The Fed didn't provide a fresh guidance on the 'taper' question Thursday, but the debate itself is reflective of the realization that the program can't continue forever. Investors have become so accustomed to the Fed pumping liquidity in the market that they see no difference between 'tapering' and 'tightening'. Bernanke's clarifications and assurances have helped stall the uptrend in long-term interest rates, but they remain elevated relative to where interest rates stood through May. The Fed's recent inability to effectively communicate its intentions about the QE program is likely a sign of things to come, as they move towards unwinding the extraordinary policy of the last few years.

 

Where do I stand?

As regular readers know, the bearish case makes more sense to me than the alternative. Simply put, I find it hard to envision stocks holding their ground in the current sub-par corporate earnings backdrop. The market hasn't paid much attention to the persistent negative earnings estimate revisions over the past year or so, likely on the assurance of continued Fed support. But with the Fed on track to get out of the QE business in the not-too-distant future, they have to start paying attention to corporate fundamentals.


Keep in mind, however, that being bearish doesn't mean that you have to exit the market. I remain fully invested and caution against the risks of market timing. That said, it makes perfect sense to position your portfolio for a period of above-average downside risk. I advocate greater exposure to defensive and non-cyclical industries, and look for attributes that many consider boring like dividend payers with solid earnings growth profiles.


To pick such stocks I rely primarily on the Zacks Rank, which helps me capture the essence of earnings momentum in any industry. Whether you are bullish or bearish in your near-term outlook, you move the odds in your favor by relying on the disciplined stock selection framework of the Zacks Rank.


Sheraz Mian is the Director of Research for Zacks and manages the award-winning Focus List portfolio. He is among the experts whose recommendations appear in Zacks Confidential.


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123Comments
Aug 1, 2013 8:24PM
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The rally will continue based upon the 85B a month pouring in.  The disturbing item is that unit sales across most industries are soft.  Management has done a really good job slashing costs and improving balance sheets.

 

There is a true disconnect between the market and the economy.  Can a 1.7 GDP number bode well, when we are creating 11% more money per year?

 

Main street sees none of this recovery.  That's OK for the upper strata, but it is crushing the lower middle class and the poor.

Aug 1, 2013 5:40PM
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Inevitably, when I get to the end of these Zacks articles, I'm left with the impression that I just read an infomercial.
Aug 1, 2013 6:02PM
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Well the paperboy, grocery bagger as well as the guy on the corner holding the homeless Vietnam Vet sign all said today they are "going all into the market" with all their chips, Jack the homeless vet was quoted, "100% in the market is where you want to be in a situation like this, remember don't fight the FED". Jack went on to say, "I fought the Viet Cong but I'll be darned if I'm going to fight Big Ben & the FED.
Aug 1, 2013 8:02PM
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hey, as long as the osama regime continues to print money we DON'T really have a viable economy it'll  go sideways as usual, 1.1% growth ARE YOU KIDDIN' ME??!!! it should be 6 at least, in a robust economy it should be north of 12 by now, but of course we're in financial ruin people, outta work and they sure as hell aren't investing, all their money is tied up in staying alive! so who's gaining here?? hmmm obama's commie cronies of course! wonder why GE isn't paying it's FAIR SHARE in taxes, hmmm interesting, ain't it!

hey but you can look at the phony numbers like a shiny new toy!

in REALITY LAND it's a different story! truth hurts you liberal vermin sleaze, I know, I know....get used to it 3more years of this nonsense and then, finally it'll be over...you vermin will be gotten rid of en masse whether the nation will survive in the meantime....don't want to even speculate!
Aug 1, 2013 9:47PM
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The market will keep going up until the taper, or when treasury yields on the 10-year go above the ability of the government to pay the interest on the debt. Both events will happen soon.
Aug 1, 2013 10:31PM
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O the rally on this yo -yo will keep going up, just before they wipe your asses out again, Fools will be fooled again and they fund their O-Abomination
Aug 2, 2013 8:21AM
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Market crash coming!  I am a seasoned trader and love it when the "Average Joe" is ebullient -- as is happening today.  Interest rate increases and inflation are on the "horizon" and neither is good for stock or bond prices.  The Fed is going to "lose" the economy through the printing of  "funny" money via a few keystrokes.  Our whole economy is FAKE!  The only thing to do is to short bonds, buy gold and then as the market "cracks" -- hit everything on the short side!
Aug 1, 2013 8:34PM
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"The rally will continue based upon the 85B a month pouring in."
 
This is all it's about. Not one single business platform can exist without it. They have no assets, work force, operations or even a product... just an administrative financial system. If Yellin replaces Bernanke we will see this atrocity continue, if we installed a backbone on our President and cleaned Congress out of Party of NO buffoons, we might see some effort to stop it before it ends us. While it continues, the clever push to convert us entirely to technology reliance takes place. Very soon we will know a far greater enemy than any politic.
Aug 2, 2013 12:26AM
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The rally will end in September and October could be a real bull slaughter by the bears.
Aug 2, 2013 6:49AM
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Can this rally keep going? As long as tax payer money is dumped into it.........
Aug 2, 2013 12:47PM
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Since we can't comment on the food stamp story:

Food Stamps are one of the most abused and wasteful social program this country has ever developed. A family of four receives more money monthly then my family of five spends a month on food. The amount paid out each month should be cut by at least one third. Purchases by food stamps should be (if not already) restricted to the following: Fresh/frozen non prepared meats & fish, fresh/frozen non prepared vegetables, deli meats/cheeses, canned goods, breads, non sweetened dairy, and non sweetened juices. The following should always be banned, and processes need to be in place where not already, to restrict: Soda, bottled water, power and energy drinks, sweetened juices, coffee, tea, ice cream, candy, energy bars, any pre-prepared meals or sandwiches, snacks/junk food, or any food that is mail ordered or shipped anywhere. If these rules would be followed, and recipients would learn how to shop and properly eat, no one would be hungry and we the taxpayers would save billions.



Aug 2, 2013 11:10AM
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The market reacting to the pitiful jobs report we had this morning....Today we are looking like the economy does, crappy....Tough to just blame manipulators for this drop, its this sorry administration's fault, they are totally clueless as far as job creation....However, they are doing great as far as scandals and being the most corrupt and unethical one in history.....Hopefully this afternoon we can at least minimize the damage.
Aug 2, 2013 2:13AM
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By any technical picture the stock market is very over bought. Today's rally only exacerbated the situation. At the very least I would expect a pull back of 10 to 15%.
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Yes, the rally might continue,but I believe it's a head fake and the more it runs up the harder it will fall when the bears finally get in the game.There is no job increase to speak of , And there is nothing to support these prices(stock). Plus may job seekers have stopped looking.
Aug 2, 2013 12:26PM
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Keep pulling the rubber band. The longer it gets pulled, the harder it is going to snap back. Its fun being a bull now.

 

Not going to be very fun when it snaps back. I bet the smart money dumps before the big price drop. History keeps repeating over and over again.

Aug 2, 2013 7:04AM
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of course the billionaires can keep the rally  going  but can also  sell at any time.  401k will eat the  bullet  still waiting for someone to tell me if billionaires  and  millionaires  are in the  401k  don't want to  here its the stock market  because they are not put into the same  regulations  a 401k  is
Aug 2, 2013 7:39AM
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The stock market isn't stable when the mere mention of easing up on the quantitative easing sends it into a tailspin.

 

Before Bernanke sneezes, surely his cronies know ahead of time, and then sell before everybody else can, pocketing a great amount of change.  When Bernanke says "just kiddin' folks" the cronies buy up the short sales and pocket the short-term profits.  I am not naive to believe this is not happening.  This is why I think the market is rigged.   It would appear the only safe haven left is the index fund, not a managed fund, if you want to solely rely on the market average, which seems impossible for the layman to beat.

 

>>> What this means is even after the Fed starts 'tapering' the QE program later this year, it will continue to keep short-term interest rates at the current near-zero level for a very long time.

 

The reason the US can get away with that is because the rest of the world is in a tailspin and no better off.  Europe, Asia, are they really a safer place to park your money.  It's still fiat currency.  It's so nice to be able to buy time like that.

Aug 2, 2013 9:44AM
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There is no such thing as already priced in. That's a myth. One of the best statements in this article is this. "Being Bearish doesn't mean that you have to exit the Market". Seems some folks still can't comprehend that.
Aug 2, 2013 11:37AM
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'The share of the country’s population that owned their homes fell to 65 per cent in the first quarter, down from 65.4 per cent in the same period in 2012 and the lowest since the third quarter of 1995, commerce department data showed on Tuesday. Home ownership is still far below the 2005 peak of 69.1 per cent.'

???????????????????????????????????????????????????????????????????????????????

WHAT'S THIS!! WHAT'S THIS!! WHAT'S THIS!! WHAT'S THIS! WHAT'S THIS! WHAT'S THIS!!
how so?, iF everything is so fantastic, and great?? far below the 2005 peak???', ah the communistic approach to free market democracy! oh don't you just love that liberal 'I hate land owners' mantra, since that's what liberals are known for, they hate the 'property owners' much like their communist brethren in ANY communist suppressive regime, sure!!!  where are all the people benefiting from this rising phony market, oops! just answered my own question didn't I.

that lazy-azzed dirtbag sleaze would own land to if it wasn't so hopped up on bad pot and eXstasy, and actually GO TO WORK! instead of bitch and moan in mommy's basement, pretending to be 'web designer' right!!! still blamin' Bush are we that your azz isn't employed?? still goin' there you vermin 5yrs down the pike, you sounded riDICulous back then now you azzwipes sound soooooo insane with that tired old mantra of 'blame game' rhetoric NOW...it's over libs, sooooo over for you it's not even funny.... and where's all the complaining about your messiah's listening in on ALL conversations, phone, txt and what not?? where's all that hate for him?? you libs are something else, you whine BUsh this and Bush that meanwhile he wasn't listening to AMERICAN's business, just that muslim filth, AS IT SHOULD BE DONE! or using the IRS and NSA as weapons against AMERICANS? hmmmm. selective hypocritical vermin aren't we! well you azzholes are in the same boat as centerists, conservatives and low life sleaze libs, enjoy!
Aug 2, 2013 1:25PM
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MR. FAT CAT...

What gives buddy? You've always tweaked these negative ninnys with insightful commentary, and intelligent responses.  Now it seems like your keyboard has been hijacked by some Junior High twit.  By the way, (as you well know), Market Bulls NEED the Anthony M.'s and the Bill Fleckensteins of the world, encouraging people to stay out of the market.  The fact that a lot of people have been reluctant to re-enter the market has made things just that much sweeter for real investors.  We don't need nor do we want weak kneed buyers of stocks.  All of these guys who have been so terribly wrong for the last 4 years are a good reason why things have gone so well for the others.  I WANT THE OLD CAT BACK!  YARRRRRRR!

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