To quote Gerald Loeb: “The market is better at predicting the news than the news is at predicting the market.” This latest rally will be a good test of that idea, in our opinion. While we believe the market is signaling all clear, the news remains glum. We face ongoing political debate over the debt limit and the Federal Reserve is beginning to talk about tightening monetary policy.
Throw in high unemployment with slow economic growth and the pessimists have the makings of an economic quagmire. Why then did the market rally 4.5% in the first week of 2013? And will it hold those gains?
We believe that after correcting its current extended position, the market will hold the majority of its gains from the November lows. And we even think it has a very real chance of setting new highs this year. As usual our opinion is based on both fundamental and technical considerations.
From a fundamental standpoint, corporate profit margins are at record highs. Company balance sheets are stronger and more liquid than they have been in decades. Tax policy is settled and capital costs around the world are low.
Central banks worldwide are pursuing currency devaluation so we expect moderate global economic expansion. And slow growth should be good for the large companies which make up the major market averages both here and abroad.
Individuals are mainly out of equities and invested in bonds. But we think they might be willing to take on more risk in stocks later this year. Stocks outperformed bonds in 2012 and we believe that should continue in 2013. Tax policy for individuals has been clarified.
Rates are permanent, and set lower than many had feared. Households are very liquid. Their overall debt to income ratio is the lowest since 1981. Housing values are improving. We expect the resulting wealth effect to cause a rise in investor confidence. And if stocks continue to outperform bonds we expect newly confident individuals to move some cash to stocks.
Longer term we believe the market is in a very strong technical condition. As a result of the recent rally most major averages are at five year highs, and within reach of new all time highs. Many indicators such as advance decline lines, moving average studies, relative strength measurements etc. are very encouraging, in our opinion.
But the most important signal may be the Dow Jones Transportation Average (DJIA).
Due to its economic sensitivity this average normally leads the market. The Transports closed January 4th at 5534, within one point of their all time high.
If this average breaks out, it could be quickly followed by the other major indices triggering a classic “Dow Theory” buy signal. And, although rare, Dow signals usually precede a long term secular rise in prices.
So although the news is bad, we believe the market says that the news is about to get better. Markets have been in a secular bear trend since 1999. Pessimism rules the day and no one believes the news will improve or that it is possible to make money in stocks. We believe lack of hope is how long market term bear markets end. And we hope 2013 marks the end of this long secular bear market.
