The question on most investors’ minds right now is whether this rally is for real or if it’s just a temporary respite within a longer-term downtrend.
The rally has legs. I suspect we’ll see the S&P 500 continue its climb for at least another month, probably running back to the 950 to 1,000 level. However, as I’ve often written lately, I seriously doubt we’re looking at a straight line higher from here. Those looking for a quick return to the bull market days leading up to the 2007 top are likely to be sorely disappointed.
There are tentative signs of a US economic recovery, or at least stabilization. The fourth quarter of 2008 or the first quarter of 2009 likely marked the trough of this recession. Although this doesn’t mean the US economy will start growing, it’s unlikely to continue shrinking at a 6-percent-plus pace for the balance of this year.
Longtime readers know I follow the Conference Board’s Index of US Leading Economic Indicators (LEI) closely. Each month I present a detailed analysis of LEI, including its 10 constituent indicators. For my most recent analysis, check out the March 20, 2009 issue.
The LEI is only released monthly, but many of the constituent indicators are reported ahead of time. Some will be sharply positive for March. For example, the stock market saw an outstanding run in the month of March, climbing about 20 percent. Because that’s a component of LEI it will drive the indicator higher.
In addition, recent reports on durable goods suggest stabilization in other parts of the economy. Even today’s jobless claims data, while far from a bullish report, suggests that the pace of job losses is no longer accelerating. All these points suggest that we will see a nice bump higher in March LEI when the number is reported on April 20. With the market trading at such depressed levels, even less bad news is good news.
And value investing legend Benjamin Graham once said, “In the short run the market is a voting machine, in the long run it’s a weighing machine.” This is why it’s important to pay attention to more technical indicators when gauging short-term market movement. On this score, I also see some signs of life; check out my chart below.
This chart shows the number of stocks trading on the New York Stock Exchange (NYSE) hitting new 52-week highs minus the number of stocks hitting new 52-week lows. During market declines, it’s typical that this indicator will register a large negative number; this just means that a large number of stocks are hitting new lows and only a handful are hitting new highs.
As you can see, the indicator touched about -2,500 back in early October as the credit crunch intensified and Congress dithered on the $700 billion Troubled Asset Relief Program (TARP). Although the S&P 500 made a new low in late November, the intensity of the selling appeared to abate. The indicator bottomed out at less than -1,500, well above its October lows.
After a brief year-end rally fizzled out in early January, the market once again plunged, breaking its November lows and touching the 665 area. Yet, while this was a significant technical breakdown, the selling intensity moderated yet again and this indicator bottomed out around -800.
This is what many technicians would call a positive divergence. In other words, while the S&P 500 itself broke down to new lows, fewer stocks within the index were actually braking down. This suggests an improvement in market internals.
Another way to look at this is to examine breadth figures; check out my chart below.
This chart shows the total number of stocks on NYSE advancing minus the total stocks declining on any given day. The raw data is extremely volatile from day to day so I tend to look at a 10-day moving average. This is what I’ve depicted on the chart above, going back nearly 20 years.
The key feature to note is the spike in this indicator to above 1,000 last month. This is a record high for the indicator. What this suggests is that in March the rally wasn’t led by just a handful of large-cap stocks bouncing off their lows. Rather, as the market advanced it was supported by a large number of stocks in different sectors and industry groups.
If you care to squint you’ll also see that the indicator never spiked above 750 in 2008. Even when the market was rallying in the spring, only a relatively small number of stocks were leading the advance.
This technical evidence, the signs of stabilization in the US economy, and indications of resurgent growth in China add up to a continuing near-term rally in the US stock market.
However, I don’t believe all is well and that this will be a stress-free bull market. The further the S&P 500 rallies, the more it’s pricing in an economic recovery--and the more vulnerable it is to tidbits of negative economic news.
The reality is that the economy is still struggling and is merely stabilizing at a lower level of output right now. While I continue to look for a tepid recovery to begin sometime in the back half of 2009 or early in 2010, there will be bouts of negative newsflow to come. These will catalyze periodic corrections in the major averages.
So far, the market is playing out roughly in line with the expectations I laid out in the Nov. 14, 2008 issue:
As I noted earlier, the S&P 500 has experienced a severe selloff in 2008 as economic woes have deepened. The most severe wave of selling occurred as the credit crunch intensified in September and October.
I suspect that the broader market is currently putting in a low for the year; we should see a rally that lasts at least through year’s end and possibly into early 2009. From a fundamental standpoint, the main catalyst for this rally will be continued normalization of global credit markets. Improvement in credit markets will alleviate fears of an outright collapse in the global financial system.
…That said, I doubt the bear market is over. Next year we’re likely to see the averages at least retest their lows as the weak economy will once again take center stage.
The good news is that 2009 will likely be an inflection year for the broader market as well; there’s a good chance we’ll see a more durable rally in the latter half of 2009 as the market begins to price in a stabilization and recovery for the US economy.
I stand by those comments. With the market in much better shape now, it’s time to look for leadership groups--sectors and stocks that will lead the coming stock market rally. Topping my list are energy and technology.
As I noted in last week’s issue and in the most recent issue of my subscription-based service The Energy Strategist, crude oil has likely hit its lows and could rally back above $80 a barrel by year’s end. The energy space is badly battered and stands to see significant gains as oil recovers. Now is an excellent time to beef up exposure to select names in the group.
The picture for natural gas is murkier. However, I’m sticking by my out-of-consensus view that gas prices stand to see a significant recovery by year’s end. I outlined this expectation at some length in a recent post to At These Levels. I also cover energy and my favorite plays in the current issue of Personal Finance, available Saturday morning, April 4, at http://www.pfnewsletter.com/.
Technology continues to handily outperform the S&P 500. Interestingly, the Nasdaq Composite only barely breached its November lows in early March, even as the S&P 500, Russell 2000, Dow Industrials and Dow Transports made significant new lows. Groups that hold up relatively well during market pullbacks often come back to lead subsequent rallies. This is likely to be the case with tech. Now is a great time to load up on big technology names such as those we’ve added to the Personal Finance Growth Portfolio over the past couple months.
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