Jury's Out
By: Sean Casterline , Senior Investment Officer

The markets jetted off their post war lows this quarter and finally gave equity investors something to hang their hopes on. It was an exciting rally that was even more inspiring because of its broad based nature. Most subgroups of the S&P 500 showed good relative strength in the quarter and many of the international markets also confirmed the action. At this point, it’s our belief this market is at a key juncture. We’ve seen tremendous technical action from the market. Yet, we haven’t seen a substantial up-tick in the economy. The economy remains biased to the upside, but it’s been a very shallow recovery thus far. As we’ve said before, earnings drive the stock market and earnings themselves are driven by the economy. The economy will be the ultimate catalyst for stocks. Thus, it’s imperative that we see further improvement/acceleration if we’re to start a new bull market. In our estimation, “the jury’s out” on this economy and the markets. That comment isn’t meant to sound negative, it’s simply a realistic look at what we’re seeing in front of us. We see real positives and negatives in this market both from the fundamental and technical perspective but neither side is a clear-cut winner in the race. Let’s break them down so you know what we’re looking for going forward.

Positives

● The low interest rate environment has been a strong catalyst for real estate refinancing activities, thus putting more money into consumer’s hands. As well, low interest rates are typically a strong catalyst for earnings growth because corporate America can borrow at low rates to expand operations.

● The technical action in the market has been tremendous. We’ve seen a broad based rally that has been driven by strong buying. Remember, the market itself is a leading economic indicator so this is a big plus.

● Cyclical stocks are leading the market recently, which is typically the way bull markets begin. The right groups are leading the market and this points toward a new economic cycle.

Negatives

æ Investors on whole are uncharacteristically bullish right now. In fact, the bullish sentiment in the stock market today, according to Investors Intelligence, is higher than it was in 2000 and hasn’t been this extreme since 1987. Bullish/Bearish sentiment is typically used as a contrarian indicator in that, when investors are extremely bullish, it’s time for the market to fall. This stands to reason because, typically, when people are bullish, they’re already invested in the markets.

● We’ve seen a substantial pickup in insider selling. If the economy’s getting better and earnings are expected to improve, why are the leaders of America selling stock in their company? It doesn’t add up.

● As we mentioned in our last newsletter, the CBOE Volatility Index (or the VIX) is at an extreme level, which typically signals a high is being put in place.

● The economy has yet to show significant signs of improvement. Investors are bidding the market up. Yet, if we don’t see economic improvement, we will come right back down.

At this moment, we’re holding a bit more cash than we normally would. As well, the issues we’re holding are mostly biased in the Health Care sector because, in our estimation, that’s where we’re seeing the most dependable earnings. Going forward, we’ll look to get more fully invested only IF we see confirmation the economy is mending. For the past three years, we’ve seen four bear market bounces and all have led to lower lows. If this is the beginning of the next bull market, we’ll have plenty of opportunity to get fully reinvested. At this point, we’re searching for economic confirmation and are guarding against the emotion that can lead to bad decisions.