You can't blame investors for feeling a bit squeamish regarding deploying new money in the U.S. stock market these days, with the Dow Jones Industrial Average's (DJIA) recent slide from 13,300 to 12,450 unnerving even the most experienced institutional investors. Where's the market headed in the next six months?
Concern about a possible Greece exit from the euro zone, along with sub-adequate U.S. GDP growth in the first quarter has created an uncertain U.S./Europe economic outlook.
Each side -- the bulls and the bulls -- is trying to make an evidence-based, convincing case that the data support their view of the world: the current demarcation line is Dow 13,000 with another key battle line being the 12,300 support level below it and 13,300 resistance level above it.
Bulls Vs. Bears Battle
The market's bulls argue that despite the fact that the U.S. economy still is not growing at robust rate -- it grew at a 2.2 percent rate in the first quarter -- the expansion continues to have legs, corporate earnings growth remains adequate-to-good, private sector lay-offs most likely have peaked, job growth is proceeding at a decent clip (an average increase of about 197,000 new jobs per month over the past six months), the worst U.S. financial and economic news probably is over, and the Dow's ability to remain above 12,000 despite a melodramatic event a day (or so it seems) from Europe, is a signal by institutional investors (IIs) that better days are ahead.
Conversely, the market's bears argue that the U.S. workforce is still unacceptably too small -- with U.S. Federal Reserve Chairman Ben Bernanke using the adjective unacceptable -- including stagnant median incomes in many job classifications. I.E., the U.S.'s job deficit -- about 10.5 million full-time jobs -- is huge. Further, that ongoing, annoying fruit fly called Europe government bonds, or sovereign debt -- means the Dow this spring is sending a false signal, and is likely to continue move lower in the summer, the bears argue.
Are the bulls correct? Or should you, Sell in May, and go away ?
Let's do a condensed, cross-methodology analysis to see if we can arrive at an informed investment decision / conclusion regarding where the Dow is headed, near-term.
Technical Indicators: Bearish. The Dow is below the 50-day (12972) but above the 200-day (12,224) moving averages -- which is a mixed reading, technically. The 50-day is substantially above the 200-day -- a golden cross -- and if that trend continues it's indicative of market strength; howeever the 50-day line is down-trending. Further, selling pressure as measured by the MacD Histogram has been strong, which is bearish. That said, the Dow, as noted, did hold support at/near 12,300 this past week. Meanwhile, the Relative Strength Index (RSI) is nearing oversold at 32, but history tells us that markets can be oversold and remain oversold (or overbought) for months, even quarters.
Fundamental Indicators: Slightly Bullish. The first quarter 2011 earnings season turned out to be slightly better than expected. Initial jobless claims are now below 375,000 and are in a downtrend, auto sales are rising, the U.S. housing sector continues to show signs of stabilizing; April existing homes sales rose to a 4.62-million annual rate in April, up from a 4.48-million annual rate in March. Also, the manufacturing sector continues to expand, and consumer sentiment is at a more than 4-year high.
Shiller PE Ratio: Bearish. The ratio, created by Yale University Economics Professor Robert Shiller, is at 21.22. That's well above the roughly 130-year median of 15.8 and the mean of 16.4.
Monetary Policy: Bullish. Despite three phases of quantitative easing (QE, QE2, Operation Twist) by the U.S. Federal Reserve, inflation remains moderate, running at a 2.3 percent, 12-month core rate in April, which excludes food and energy prices, and a 2.3 percent rate overall. That moderate inflation, combined with the output gap, means the Fed will, at minimum, continue to reinvest the proceeds of the second stage of its quantitative easing policy to help stimulate the economy, 'QE2,' through at least the start of the third quarter, and perhaps for longer. Also, the Fed, in its most recent statement said maintained its language that U.S. economic conditions are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.
Fiscal Policy: Bearish. Most recently, the U.S. Congress, due to the Tea party-pressured Republican majority in the U.S. House, implemented austerity measures too soon. Deficit reduction and weeding-out needless programs are laudable goals, but reducing the deficit too fast -- especially if spending cuts affect the social safety net - reduces demand, and could very well increase social problems -- leading to even higher social costs down the road. There's also little empirical evidence to suggest that decreasing public sector spending amid sluggish consumer spending and tepid business investment will strengthen the economy.
Credit Markets: Recovering, but still strained, with still too many small/medium-sized businesses arguing they're not getting the level of credit they need to expand operations. Home mortgage qualifications terms remain very high. Home mortgage rates, however, are at/near 40-year lows, at an average of 3.73 percent for a 30-year, fixed-rate mortgage, for home buyers with excellent credit.
However, Europe's sovereign debt situation remains clouded, and there could be more financial market ripples. The major question mark concerns Greece's ability to reach an agreement with the leaders of the euro zone to modify its bailout package. Greece's contracting economy means the nation will not be able to service its debt, given current repayment terms. However, to-date, Germany has taken a cautious stance toward more-lenient terms, with Chancellor Angela Merkel preferring to wait until Greece's June election before conveying her sentiment. (The risk of contagion in Portugal or Spain are also keeping investors awake at night: some analysts say each will require a bail-out. So far, each has said they will not need outside intervention funds.)
Conclusion: The view from here argues that the outlook for U.S. stocks and the U.S. stock market is Slightly Bearish for at least the next three months -- through early August.
The current stock market remains highly selective, and the bias is toward only deploying capital in those clear-winner stocks.
In sum, the market needs bullish U.S. economic data (such as stronger job growth) -- and some sign that Europe's debt crisis is being resolved -- to help sustain current Dow levels.