Saturday, March 3, 2007

The Bullish Argument Going Forward

This is the Barron's cover story this week (subscription required). The article makes some good points.

Before Tuesday, every major stock market in the world -- and nearly all the smaller markets -- were near 52-week highs. Most markets also were near record levels, with the notable exceptions of the Nasdaq Composite and Standard & Poor's 500, a reflection of the absurd valuations they had reached in the tech boom of 2000.

.....

A bullish Wien thinks the S&P 500 could hit 1,600 by year end, a 15% gain. He says U.S. stocks look attractive with the S&P valued at 15 times projected 2007 operating earnings. The Dow Jones Industrial Average trades at 14.4 times estimated "07 profits. Both the Dow and the S&P 500 are in negative territory for the year, with the industrials off 2.8% and the S&P 500 down 2.2%. The so-called earnings yield on both the S&P 500 and the Dow is close to 7%, which compares favorably with the 4.5% yield on 10-year Treasuries. The earnings yield is the inverse of the market's price-earnings ratio.

Companies continue to lift dividends and repurchase record amounts of stock in order to reward shareholders -- and stay out of the sights of private-equity shops on the prowl for new leveraged buyouts.

.....

HISTORY SUGGESTS THAT STOCKS MAY DO WELL in the next two months. There have been 38 days since 1979 when the S&P 500 has suffered a single-session loss of 3% or more. The average gain in the ensuing 60 days has been 6.9%, with the index rising in 31 of the 38 cases, according to Citigroup research.


There are some very solid technical arguments here. First, the market isn't cheap but certainly not expensive by historical standards. While corporate profit growth is expected to slow, it is still pretty healthy. And traders are conditioned to buy on dips, meaning there could be some buying nibbles at attractive technical levels over the next few weeks.

The article does state overall slowing economic growth is the primary reason the markets may not advance. This is a strong counter-argument. As I wrote below, there was a ton of bad economic news last week that provided the fundamental reason for the continued market weakness throughout the week.

I still think housing is the main wild card going forward. There is still a ton of inventory to clear and last week's numbers indicate it will take lower priced to do it. Housing starts are slowing, which means we will probably have a large amount of construction lay-offs in the coming months. However, the business construction sector may absorb some of these displaced workers if non-residential construction levels continue at current levels.

I wouldn't be surprised to see the market far more sensitive to bad economic news over the next few weeks. Up until last week, the market was able to shrug off some bad news, basically arguing that problems were contained within specific market sectors -- especially housing problems. However, I think we'll start to see some of housing issues -- especially in the mortgage area -- start to spread-out to other market sectors like financials (mortgage related issues) and consumer durables (furniture/appliances).

Food for thought