Everybody Back In the Pool.

The Fed seems to be taking a more accomodative approach going forward and stocks are smoking higher. Again use this as an illustration of why investors sometimes need to anticipate in accordance with their risk profiles. Folks that pulled out the past couple of weeks had almost no chance to get back in as the markets have just exploded higher today.

Snore.

The markets trade like nobody is interested. Stocks move in pennies one way or the other. Nobody cares until after The Federal Reserve meets on Thursday. We can all go away until then. I had to republish some earlier posts that for some reason didn't show up in the blog. Go back and reread everything from June 11th on. Sorry for the delay & confusion.

Any Chance Of A Summer Rally?

What are the chances that stocks shake off their late Spring funk and exert some form of rally? Let's take a look and see if the ingredients are in place.

Investor Sentiment: Presently, fear permeates the market place (particularly, in the before mentioned three key sectors in 2006 of commodities, energy & foreign markets, especially those of an emerging kind). Contrast this with market sentiment at the end of April which basked in the glow of a rising tide in the most speculative sectors.
Volatility: Both in time and price, the recent decline has been historic as liquidity has been withdrawn from the markets and most of the winning trades of early 2006 have been unwound.
The Federal Reserve: The Fed has in effect used its public podium to telegraph future rate increases at least in regards to June and likely in August. They have been able to do this without raising interest rates in the interim interval. While many blame the new Fed Chairman for a two faced approach to the public he has in essence jawboned the markets by reducing investors exposure to risk in speculative sectors while at the same time reducing the equity risk premium to more normal levels. In particular his words and actions have impacted both corporate and consumer actions while at the same time leveling out commodity prices. .
Proprietary Measures: Many of you are aware that I follow 14 proprietary measures of investor sentiment and indicators which measure money flows into and out of the markets. These measures have deteriorated to levels that are consistent with prior market bottoms.
Investor Disgust: The options back dating scandal as well as the culmination of the Enron trials have brought out the usual naysayers (perhaps more openly at this time) that equities should be avoided, the market is rigged and all corporations are crooks. This is typically a contrary indicator.
Inflation: Inflation fears seem to have now been priced into stocks.
Valuation: Per my previous posting on PE's stocks are now at levels where they have historically found value. Consensus S&P earnings expectations remain high but are beginning to move lower, and stocks seem to have already discounted a possible slowing of earnings either later this year or in 2007.
Corporate Actions: "Watch what they do, not what they say" is an old investment saying. Corporate America has been very active in 2006. The level of corporate buybacks, mergers and takeovers is close to historic levels. Investors might not think the markets are cheap but corporate America by their actions is saying stocks are attractive.

Muted Rally Must Wait Until After The Fed. Stocks could be poised for a summer rally and not the beginning of a rip roaring bull market. Stocks are like a coiled spring after their recent pasting and are just looking for an excuse to rise. But the market is likely going nowhere until after the Fed meeting June 21-22 and the almost certain 1/4 point rise in interest rates. A summer rally is possible after that point but issues such as slowing corporate growth, uncertainty regarding our fall elections, rising international tensions & late summer lethargy are likely to put a cap on any rebound before Labor Day. We will monitor our indicators over the summer (as well as go into more detail about what they are and how they work) and be prepared at that point to get more defensive if we need to. But for now a rally is more likely than not after the Fed meets.

A business note!!!!!! I am going to be in and out of my office on business and some personal matters over the next two weeks so posting is going to be very light to non-existent. Look for more posting and more detail after the 4th of July.

Investor Sentiment.

AAII data (which we have discussed in the past in context with investor inflows and outflows of cash into mutual funds) was out today with some of it's highest bearish sentiment readings in months. Bearish sentiment came close to 55% up from 44% as of its last reading. You have to go back to 2004 and before that 2003 to find readings that high. Predictably the market rallied hard today. This rally slightly relieved its over sold status. However, my indicators still show that there is room for stocks to rally. This is likely to not occur however until after the Federal Reserve meeting later this month.

Putting Things In Perspective.

Quoting from Birinyi again as I thought this piece very timely.

Merrill Lynch's Chief Economist, David Rosenberg outlines five reasons why investors shouldn't panic:
1. We've gone 820 sessions now without a 10% correction in the broad market, which is the third longest stretch ever. We have been overdue for a pullback for some time.
2. The forward P/E has compressed to a mere 14.1x – back to where it was in mid-October 2005 right around the last time the market was when it began to find its legs.
3. Massive buybacks – over $100 bln this year or +22% year-over-year.
4. Earnings backdrop remains strong (at least for the current quarter). Negative pre-announcements remain lower than last year's levels.
5. Inflation expectations are starting to subside. Gold, Copper, Silver, and other major metals are all well off their recent highs, the dollar is strong, and the yield curve is flattening again.

Source: "Ticker Sense", Birinyi, Laszlo. June 14, 2006

Market PE Ratio

S&P 500 P/E Ratio

This information comes from Laszlo Birinyi's blog "Ticker Sense" Birinyi is a top notch economist who I have followed for many years. As he shows the P/E ratio (trailing 12 month) of the S&P 500 is currently at 16.64. We have to go all the way back to October 1995 to see a ratio this low (16.02 on 10/26/95). As he has stated before, the PE ratio on the S&P 500 has contracted more than in any other economic recovery.

Source: "Ticker Sense", Birinyi, Laszlo. June 13, 2006.

You can link to Birinyi here: http://tickersense.typepad.com/ticker_sense/

Volume

Market sentiment has been eroding along with profits. My indicators are now at some of the lowest readings seen since last fall. The biggest drag on the markets has been those areas that went up the most earlier this spring. These are the big three I discussed last week: Commodities, energy and especially foreign securities/markets. For the most part these markets have been hit harder than ours.

There has been a lot of commentary about a slowdown in volume over the summer. This seems likely for a couple of reasons one being that summer is traditionally a slower period as traders are often seen as being more interested in the beach than their screens. Midweek holidays such as July 4th this year and an August largely seen as unexciting should not help in the volume area.

Given the way the market has sold off in the last month I would think that we would need to see a real surge in demand to retrace most of what we've given up. However, the market is so over sold that it is likely that some sort of snap back in prices is possible short term and perhaps even a small rally through the early weeks of July. The markets globally started to sell off mid May and at some point a snap back rally is likely to occur.

Liquidity

The markets fell off the charts in May. Rather, they fell out of bed midmonth after the Federal Reserve indicated they were not yet done raising interest rates. This comes amidst evidence that the world wide spiggot of easy money is being shutdown via global rises in interest rates. Since higher rates translates to less market liquidity the choppy period we've been going through makes sense. I believe that since sometime last summer -as returns in general market indexes have stagnated -that speculators have taken much higher and inappropriate risks by buying an increasingly narrow body of asset classes and equity sectors. Namely everything related to commodities, energy and international have been golden. Everything else has been punk.

These areas have started to take on some of the same aspects as technology in late 1999 early 2000. That is in spite of high valuations you could find high level of investor complacency regarding the valuation of these securities. Until mid-May, euphoria ruled the roost in these sectors. CNBC talked of nothing else and the business press did nothing but tell us why "This time it is different" although it almost never is.

I hate the words "investment bubble" because it is used all the time to describe any parabolic move in an asset classes. The idea of a new era/paradigm is often re-introduced to investors to explain these types of moves. Unfortunately it seems to be an automatic about the human condition to always need to provide some rationale to in the end what amounts to little more than some type of momentum-based buying strategy. These rear-view statistics almost always include things like last quarter's corporate profit growth, prior month's retail sales activity, P/E ratios, large corporate cash hoards, subdued inflation and interest rates.

Now the "bubble" in these can't miss asset classes seems to have been at least for the time being deflated if not in some cases longer term popped. Now market participants seem repelled by the tandem effects of rising global interest rates and Fed Chairman Bernanke's hawkish yet convoluted musings on more interest rate increases. As such fear seems to have engulfed Wall Street. Fear is almost always translated to higher volatility which usually means lower stock prices.

The markets are reaching a point of soon being very over sold. I believe that there is at least 1 to maybe 2 more rate increases in store this year as the Fed worries about inflation and continues to look at the economic data to find evidence that it is contained. The market could be in for a few more rough weeks but should set itself up for a better buying opportunity later in the month.