INTELLIGENTVALUE SAMPLE NEWSLETTER:
I am reading on the internet and hearing on TV from more and more bears who are appear to be getting more and more desperately frustrated by the bull market rally we've experienced since March 9. Their rants are getting more extreme with each passing day and each rise in the market.
By Christopher Michaels
IntelligentValue.com
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Even very experienced market analysts, such as John Mauldin, are prone to raise irrational points in an attempt to support their constantly bearish outlook these days. According to Mr. Mauldin's newsletter a few days ago, "Today, there are those who say the stock market will start rising six months before the economy does. And maybe it will. I don't know. The predisposition of this market is down. Valuations are not at a level that has spawned major bull markets in the past."
As astute and erudite as Mr. Mauldin is, I find it amazing that he advocates being out of the market for the last 2 1/2 years - since August 2006 - and apparently, many years going forward. Saying that valuations are not at a level that has spawned major bull markets in the past is patently absurd. The last bull market - the 2003 bull market - began with a P/E of 21 on the S&P 500. Today the P/E of the S&P 500 is 14. Bears are just making things up out of thin air to support their thesis and try to shore up the losses on their short positions.
The bears are trotting out all kinds of bizarre worries in an attempt to get the market to pull back. But all bull markets begin by climbing a wall of worry. The list of worries these days, real and fabricated, is enormous and there is no end in sight. But if we ignore the human-generated worries, there are a few scientifically based harbingers of bull and bear markets that have proven to be very consistently accurate. The news of the day and the long list of problems make no difference when you conduct a cool, cold hard analysis of the numbers that do make a difference.
One of those numbers that has been foolproof for more than a century is the leading economic indicator published by the Economic Cycle research Institute (ECRI).
ECRI LEADING INDEX
The ECRI Leading Index is a composite of seven indicators chosen for their ability to signal both the beginning and the end of economic recessions. Since 1970, a significant downturn in the index of leading economic indicators has preceded the beginning of a recession by about 10 months; a significant upturn in the index has preceded the end of a recession by an average of 2 months.
ECRI's publishes two indicators for big money managers, banks and governments. The U.S. Long Leading Index (USLLI), has the longest average lead times of any U.S. leading index. The organization also publishes the Weekly Leading Index (WLI), which has a shorter lead over the business cycle, but is very promptly available.
According to the ECRI, "The growth rate of the USLLI turned up in November 2008, and has now advanced for four  straight months. The growth rate of the WLI turned up soon after that, in early December 2008, and, as of mid-April 2009, had been rising for more than four months (top two lines in chart on the right). A rigorous examination of the data affirms that both USLLI growth and WLI growth have been in cyclical upturns for at least four months.
Therefore, the economy is on the cusp of a growth rate cycle upturn – i.e., a cyclical acceleration in economic growth. In other words, U.S. economic growth, which, according to ECRI's U.S. Coincident Index growth rate, is still plunging deeper into negative territory (bottom line in chart), will start becoming less negative in short order.
But so what? Isn't this tantamount to the growing conventional wisdom about the slowing descent in economic activity? Indeed, but those who dismiss this development don't understand its implications for a business cycle recovery.
In fact, over the last 75 years, growth rate cycle upturns during every recession were followed zero to four months later by the end of the recession itself. No exceptions."
What's most important to IntelligentValue subscribers is that soon after a trough in the ECRI indices, the stock market begins to perform well. The ECRI index troughed at almost -10, the lowest level since the bear market bottom in 1975. The stock market also troughed and since early March has headed strongly higher. This trend could continue for many months to come.
Bull Market BEGINS?
Net advances over the past 10 days are the third strongest ever, but I see a case for even more gains. The average one-year bear market rally off of the bottom has risen more than 43 percent. This market has risen 34% and it's likely there is still room to go higher. Despite the 34% rise in the S&P 500, the P/E of the index has dropped to 14.33 from the mid-20s just a few weeks ago. That's because reported earnings are rising faster than the market is climbing.
With only about 10% of the $850 billion Obama stimulous bill in the economy to date, the billions that are coming will have the effect of turbocharging an upturn that's already started.
Another factor is that there are lots of investors who missed the moves in the last two months and are sitting with large cash hordes. The amount of money in Money Market Mutual Funds, earning essentially nothing is still massively larger than the amount of money in stock mutual funds. And even though the market has risen 34%, only 29 percent of the S&P 500 stocks are above their 200-day moving average. But the most stunning indicator is that the number of days to the first correction in previous bull runs is 194 days, and we are only at day 53.
Just as investors become overexcited and think that good times will never end at the top of a market, they emotionally overshoot to the downside and think that we are in the Great Depression II. Last November, some subscribers were e-mailing me about the coming food riots in the streets and the coming soviet society we would live in. At the time, I told them, 'Hogwash!' As my former employer used to say in their advertisements, 'I'm bullish on America!'
The recession that has now ended is simply another business cycle that happens about every 4.5 years. What happened to cause the market to collapse last October and November was the breathless, frightening public announcements by Treasury Secretary Henry Paulson and President George Bush on national television. Those halting appearances to let us know the economic foundation of America was near collapse were totally uncalled for and will always be a closing reminder of the failed Bush administration's eight years in office - eight years of the worst President in my 50 year lifetime.
It wouldn't surprise me a bit to see the market recover rapidly to the 1250-1350 level on the S&P 500 - the level the market was at before Bush, Paulson and company made us all feel that it was the end of the world.
Don't get me wrong, I'm no slobbering fanatic about current President Obama, but it's refreshing to see a world leader that can actually complete a sentence. Regardless of what you think of Mr. Obama's policies and anti-business rhetoric, the man does inspire confidence - exactly what has been missing from the stock market since September, 2008. So, I say it's possible we could see another 40% rise in the market over the next 6-9 months back to the status we were at before the end-of-the-world rhetoric from Bush and team began. Remember that last September the market had already dropped about 25%, so we were still seeing a more normalized post-WWII recessionary downturn before the market fell off a cliff.
This isn't to say that it's all wine and roses from here. Housing will muddle through and slowly turn up over the next two months and job losses will continue for the next year or more. But job losses are a long-lagging indicator. Even a year or two after a recession bottoms, companies are still cutting jobs. But that makes them lean, mean profit machines - perfect for investors. Today is the ultimate time to buy assets, whether that's real estate or equities. Buy, buy, buy before everyone else catches on.
MONEY ON THE SIDELINES
Having spent time in the trenches at Drexel Burnham and Merrill Lynch, I know that the big institutional money managers always look at the 200-day moving average of the S&P 500 as one of several key thresholds for getting back into the market.
The similarities between today and the 2003 bottom are striking to me. In March 2003, we had the third downturn of the 2002/2003 recession and the market began to rise strongly. Just as today, there were many, many analysts and commentators that were saying there were worse times ahead and at a P/E of 21, the market was nowhere near a bottom.
But the market continued to rise as the S&P 500 moved through the 200-day moving average in May of that year and institutional money managers came back into the market, putting trillions of dollars to work in money-making equities. This phenomenal money flow drove the market higher for another 9 months until the first significant pullback came in March 2004.
Today, the market is headed toward the 200-day moving average later this month. Chart courtesy of StockCharts.com.
The March 2003 low started a bull market that moved through the 200-day moving average in May, bringing in the large institutional money. Chart courtesy of StockCharts.com.
OUR STOCK PICKS
With the recession 'over,' housing bottoming (and in some areas already turning up), retail sales in growth mode (0.7% gain this week), jobless clams declining and broad positive economic growth beginning, we should be seeing a continuation of the V recovery in the market which could continue for quite a while. While there are several sectors that are overbought, the broad market (S&P 500) is still far from overbought with a Relative Strength Index only at a reading of 65. Investors are still buying the most beaten down stocks and should continue to do so at least until the big money comes in at the 200-day moving average.
Our Aggressive Portfolio, which has produced a return of 836% in the last 36 months (led by OCNF with a gain of 47% to date), will be getting four new positions for purchase at the open tomorrow. These stocks are small and very aggressive, but they should return excellent performance in the short term. The current pullback gives us an opportunity to buy at decent prices. I'm looking for a total return in the Aggressive Portfolio of more than 1000% within the next week, just in time for its 3-year anniversary on May 16. No guarantees, though...
Our Model Portfolio, which I consider to be the 'conservative portfolio,' has beat the S&P 500 by about 165% since its launch in September 2004. With the market still rewarding the most beaten down stocks, we're going to pick a couple of stocks tonight that may make you sit up in your chair. S&P 500 constituent CitiGroup is one of our picks.
Before you choke on your chips, let me point out a couple of facts; although Citi is the most highly shorted stock in the S&P 500, its insiders have been buying at a breakneck pace. What do they know that we don't? With the now famous 'stress test' results coming out on Thursday and the jobless claims report on Friday, these big news items will be the catalyst that could send the financials and the market sharply higher. Many are fearing these reports - we're going to embrace them.
I'm hoping we get another, stronger pullback on the open tomorrow to lock in our prices. Remember that when we send out a Buy Alert in the evening, the prices will be adjusted to the opening price of the day in the Price Adjustments section. Model Portfolio picks are always made the evening before a purchase; Aggressive Portfolio picks can be made intraday.
Also remember that all the IntelligentValue stocks are optionable, so if you don't have 100% confidence in my thesis, you can pick up an option on these bargain basement companies for pennies. We're also going to keep our stops tight on each stock, which will prevent significant losses while letting profits run. The stop prices are in the third column from the right in the portfolio tables:
Sincerely,
Christopher Michaels
IntelligentValue.com
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