Posted | by David Moenning |
A Fistful of Reasons to be Optimistic image

Despite all the worry, fear, and/or uneasiness in the markets these days, the S&P 500 closed Wednesday within spitting distance of an all-time high (0.63% to be exact). Not too shabby for a "hated" stock market, eh?

Yep, that's right, despite the global economic slowdown, the ongoing trade war, the unrest in Hong Kong, the consternation over a "hard BREXIT," the political turmoil in Washington, the $17 trillion in bonds that carry negative yields, some serious volatility over the past year, and the weekend attacks on Saudi oil facilities, the stock market appears to be, well, doing just fine, thank you.

It is also worth noting that so far at least, the stock market has been thumbing its nose at what traditionally has been the worst month of the year. Don't look now fans but the S&P 500 is up 2.85% so far in September and is up nearly 22% on the year.

Yet before you uncork the champagne, we should keep in mind that stocks have gone next-to nowhere over the past twelve months. My trusty calculator says that the S&P 500 index was up just 0.4% for the last 12 months at the beginning of September. And from the January 2018 high through yesterday, the S& is up a less-than inspiring 4.7%. Oh, and lest we forget, investors were treated to pullbacks of -19.6%, -6.8%, and -6.1% during that time. Joy.

When all the worries are coupled with the multiple sharp pullbacks, it is easy to understand why investors appear to be less than enthusiastic about the prospects for the stock market these days.

Reasons To Be Optimistic

However, given that I'm a card-carrying member of the-glass-is-at-least-half-full club when it comes to the U.S. economy and stock market, I'd like to offer up a fistful of reasons to be hopeful about the market going forward. So, without further ado, let's get to it.

1. There is Nothing New Here

One of the oldest clichés on Wall Street is the market likes to climb a wall of worry. And while there is indeed much to fret about these days, I believe it is important to recognize that with the possible exception of the attacks on Saudi's oil facilities, the rest of the issues are even remotely close to being new.

This means that market players have had time to ponder the future and to discount the likelihood of a negative outcome for each issue. Markets climb a wall of worry as traders/investors come to the realization that the big, bad fear isn't likely to impact the sales of Coca Cola or Microsoft software, people's discretionary spending, or their searches on Google.

Sure, the trade war is definitely having an effect on the manufacturing sector. A quick peek at FedEx's statement confirms this as the company's CEO said Wednesday, "the absence of a trade deal with China has reduced the movement of goods internationally."

But remember, in the good 'ol USofA, it is the consumer that accounts for something like 70%+ of GDP. So, as long as jobs are plentiful (check), incomes are rising (check), the value of homes and 401Ks are rising - or at least not falling (check), then lots and lots of companies will continue to make money. And it follows that if corporate profits are rising, stocks can rise too.

Thus, once an issue becomes well known and that issue doesn't actually threaten economic life as we know it, investors tend to figure out that there is nothing to fear but fear itself - in the long run, that is.

2. The Central Bankers Are On The Case

One of the most important lessons I have learned in this business came from the late Marty Zweig and his pal Ned Davis. This duo was responsible for making the phrase, "Don't fight the fed" one of the key rules investors have lived by over the last 30+ years.

The reasoning is simple. Over the years, I've come to realize that central bankers tend to get what they want. Paul Volcker declared war on inflation by raising rates. It worked. Alan Greenspan needed to avoid a big problem after stocks crashed in 1987. It worked. Ben Bernanke wanted to avoid a Japanese-style deflationary spiral after the financial crisis. And while we can agree to disagree about the methods employed, this too worked.

My quick point here is that central bankers from the US to Europe, to China, and to New Zealand currently all want the same thing - to avoid recession and/or to keep the economic expansion alive. Therefore, it makes sense (well, to me, anyway) to recognize that the bankers just might get what they want once again.

So... If the central bankers get what they want, then the economies of the world will continue to grow - it's only the rate of growth that is in question. And if the economies of the world are growing, well, stock prices can rise.

3. Market and Economies Are "Managed"

Continuing on this theme, here's a message for all the doom & gloomers out there: Beware of getting too negative. Why? In short, because I'm of the mind that markets and economies around the globe are more "managed" than ever.

We capitalists like to poke holes in the communistic and socialistic approaches. But make no mistake about it; government officials and global central bankers are doing their level best to keep economies and markets movin' on up.

In my humble opinion, it is important to recognize that the major economies of the world can't afford another crisis, wicked recession, or brutal bear market in stocks.

So, while I'm sure we can argue about the effectiveness of the various policies likely to be used during a crisis, we must realize that if something bad happens out there, a monetary and/or fiscal policy response is almost certain to follow. And as I recall, the stock market has traditionally viewed such responses in a positive light.

4. Two Cuts Is Better Than One

Yesterday, Powell & Company cut rates for the second time. What's interesting here is the history behind "2nd Rate Cuts" is promising.

The good folks at Ned Davis Research Group have done extensive research into what happens after the U.S. Federal Reserve cuts rates a second time. The results are clear. Three months after a second rate cut, the Dow Jones Industrial Average has been higher by an average of +9.7%. Six months later, the average gain is +12.1%. And one year after a second cut, the venerable Dow has been up +20.3% on average.

Here's the fun part. According to NDR, it hasn't really mattered to the market if the economy winds up going into a recession after a second rate cut. NDR analyst Ed Clissold found that when economy entered recession after a second rate cut, the Dow's average gain six months later was +11.2% (versus +13.8% when the economy did not enter recession). And the gain a year later even with a recession was 18.2% (versus +21.5% with no recession). Interesting, right?

The key here is to understand that the Fed is usually "behind the curve" when cutting rates. On the other hand, stocks tend to discount the future. Thus, the timing here makes sense. By the time the Fed gets around to recognizing there is a problem and has cut rates for a second time, the problem is usually closer to ending than starting, and stocks have already "sniffed that out."

5. So Bad That It's Good

To be sure, investor sentiment is a tricky business. And trying to trade on a contrary basis is fraught with risk (remember, everybody can't be a contrarian!). But an important lesson I learned from Ned Davis is to wait for sentiment to first become extreme and then reverse, before thinking about taking action that goes against the current trend.

For example, NDR has a daily sentiment model that measures a host of indicators dealing with how investors are thinking, feeling, and acting. Recently, Mr. Davis pointed out that when this model gets low enough (meaning that investors had likely succumbed to the fear of the day and have already done their selling), stocks have tended to rally an inordinate amount of the time.

According to NDR statistics, when their sentiment model falls below a critical threshold, stocks have been lower over the next month only once since 2005. Looking at the data, I found that there were 26 cases since 3/29/2005 when the model fell below the key level. And only once was the S&P 500 lower 21 trading days later.

For those keeping score at home, this means that stocks moved higher 96% of the time after sentiment effectively became "washed out." In other words, there are definitely times when sentiment gets so bad that it's actually good!

Summing Up...

In short, there are lots of things to fret about in the stock market. And from a near-term perspective, the gap on the daily chart of the S&P 500 down to 2938.34 is likely to be filled at some point soon. But from a big-picture perspective, I believe there are at least a fistful of reasons to be optimistic.

As such, I'm of the mind that a "buy the dip" strategy remains a great way to play Ms. Market's game.

Thought For The Day:

Procrastination is the art of keeping up with yesterday. - Don Marquis

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research

HCR Focuses on a Risk-Managed Approach to Investing
What Risk Management Can and Cannot Do

Disclosures

At the time of publication, Mr. Moenning held long positions in the following securities mentioned: MSFT - Note that positions may change at any time.

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