Monday, March 5, 2012

Why I am still bullish

As the stock market consolidates and the Dow flirts with the 13K level, there have been some calls for an intermediate term top. I remain bullish over the next few months for the following reasons:
  • The risk trade bull run remains intact
  • Positive funds flow are buoying the markets;
  • Panic levels are still elevated;
  • "Expert opinion, defined as the better market timers, are bullish;
  • The Bernanke Put and Draghi Put still lives; and
  • The China property bubble lives on for another day.

The risk-on trade is still "on"
If you were to view the stock market through the lens of the risk-on/risk-off trade, then the risk-on bull move remains intact. Consider this chart of the relative performance of SPY against IEF, which shows a short-term relative uptrend in the context of an intermediate term uptrend.

Positive funds flows
Josh Brown pointed to a Reuters article indicating that institutional equity funds flows are positive. He went to say that they are likely to continue:
In my experience, these types of raising and lowering equity exposure cycles take place at a glacial pace and they rarely turn or stop on a dime.
Scott Grannis wrote that individual investor equity funds flows are just starting to turn positive and there is a lot of room for them to go further into stocks:

...and out of bonds, whose flows are still positive:

Grannis' conclusion was:
Adding it all up, I would say that we are a long way from seeing over-priced equities. Let's wait to see many months or even a few years of inflows to equity funds before concluding that the guy on the street is too bullish.

Panic levels are still elevated
Also consider the readings of the Crash Confidence Index from the Yale School of Management. A low level indicates a high level of fear and a high level indicates a high level of complacency. While the ECB's LTRO program has largely taken the risks of a banking meltdown off the table, investors confidence remain low and fear levels are still elevated. I interpret these conditions as being contrarian bullish.

"Expert" opinion is bullish
Mark Hulbert reports that the best market timers are leaning bullish, while the worst market timers are leaning bearish.
As an example, I don't know where the Aden sisters are in Hulbert's ratings, but I have tremendous respect for them and they are bullish. I have followed them, off and on, since the late 1970's during the gold mania that took bullion up to its peak of $850 in 1980, which they correctly called. Unlike other gold bugs, they turned bearish on gold and turned bullish on equities in the intervening period. They correctly called the rebirth of the commodity bull about ten years ago.
The Bernanke and Draghi Puts still lives
Ben Bernanke, in his testimony to Congress last week, said in so many words that QE3 isn't a done deal and they are watching the data carefully.

In light of the somewhat different signals received recently from the labor market than from indicators of final demand and production, however, it will be especially important to evaluate incoming information to assess the underlying pace of economic recovery.
The markets sold off but the flip side of this coin is that they are ready to act should the economy weaken.
The dual objectives of price stability and maximum employment are generally complementary. Indeed, at present, with the unemployment rate elevated and the inflation outlook subdued, the Committee judges that sustaining a highly accommodative stance for monetary policy is consistent with promoting both objectives.
So does that mean that good economic news is good news for the markets but bad news isn't necessarily bad news?

As for the ECB, interbank lending in Europe is still seized up. This analysis shows that the European banking system needs another four LTROs to get through to 2013. Don't be surprised if the ECB announces further rounds of LTRO.

In short, the Bernanke and Draghi Puts will "put" a floor on the stock market for now.

The Chinese property bubble lives on another day
Walter Kurtz, writing at Pragmatic Capitalism, noted that the property market in Beijing and Shanghai are recovering. Such a development should forestall any immediate concerns about a crash in the Chinese property bubble as official actions have kicked the can down the road and delayed the day of reckoning yet once more.
The Shanghai Composite has responded with a rally as a result of these measures. As the chart below shows, the index has rallied through a downtrend line and it has not even approached the first Fibonacci retracement level, which would serve as a resistance level.
Bearish tripwires
To be sure, not every market forecast is correct. Here is some of what I am watching for to see whether the bears are wrestling control of this market away from the bulls. These are some important questions that need to be answered in order to determine the next major move in equities.

First and foremost, the big question is can the Dow can overcome the 13K mark?

Looking at foreign markets, can the Hang Seng overcome resistance after rallying to fill the gap depicted in the graph below?

What about Europe? The Euro STOXX 50 appears to be undergoing a sideways consolidation. Can it rally to overcome resistance?

The cyclically sensitive Australian Dollar is temporary stuck in a trading range. Will it break out to the upside, which is bullish, or to the downside, which is bearish?

Another important cyclical indicator is the relative performance of the Morgan Stanley Cyclical Index against the market. Cyclicals started 2012 on a tear, but they have begun to consolidate sideways on a relative basis. Can the relative support level hold?

Lastly, technicians have been sounding words of caution because the Dow Transports have been lagging and have not confirmed the advance of the Industrials Average. Mark Hulbert writes that there is some disagreement about prominent Dow Theorists about the significance of this divergence:
Frustratingly, not all Dow Theorists agree on an answer. In fact, two of the three monitored by the Hulbert Financial Digest — Jack Schannep of and Richard Moroney of Dow Theory Forecasts — think the appropriate point of comparison is not last summer but late October. And because, near the end of December, the Dow averages rose above their late-October highs, both Schannep and Moroney believe that the Dow Theory is solidly in the bullish camp — notwithstanding where the Dow transports might be relative to their July high.

In contrast, Richard Russell, editor of Dow Theory Letters, says he’s worried about the Dow transports’ weakness and, in part for that reason, is largely out of the stock market.
The chart below shows the relative performance of the Dow Jones Transports against the Dow Industrials. If relative performance were to fall below the 38% Fibonacci retracement support level, it would mean that the bears have taken control of the market.

In conclusion, I believe that equities are consolidating their gains but remain in an intermediate bull phase. During this consolidation period, doubts will appear about the legitimacy of the bull leg, as they are now. My view is that the next major move is up, but I am watching and open to the possibility that I am wrong and a correction can run deeper than I expect.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

1 comment:

Onlooker said...

I'm more than a bit skeptical of Grannis' view of the retail investor. I think it's more likely that we see continually increasing apathy with each cycle as we progress through this secular bear. By the time we're done there will be downright revulsion.

I don't follow him at all, but it seems that he's a bit of a permabull, no?