The Market Rally that Everyone Hates!

by Wayne Ferbert on August 28th, 2012


Somewhere online, I saw this rally called "The Rally that Everyone Hates." I can't take claim for this title. But I tend to agree with the observation.

I don’t remember a stock market rally that has had more naysayers than this one! This seems like the rally that everyone wants to fade. CNBC and Fox Business will always have Bulls on TV to make their case. But it seems like even those stations have had a fair share of Bears on making their case.

Don’t get me started on the blogosphere and this market rally. The blogosphere seems even worse. You know the arguments: this rally is on low volume; corporate earnings guidance was weak for the 2nd half of 2012; companies dependent on Europe for earnings have shown weakness; the economy doesn’t show enough signs of improvement. The reasons are endless to fade this rally!

But the rally has steadied itself around this $1410 level in the S&P 500. So, what do we make of this rally? What do we think is driving it?

I am starting to believe that it is the value investor community that mostly invests for the long run that is driving this Summer rally. I think mutual fund money and the long-term investor are looking at the multiples here and saying: “I feel good about the value I am getting for my money.”

Look at this chart of US Corporate Profits After Taxes for the last decade. Earnings have recovered to surpass their pre-recession highs. In fact, they are well above the levels they reached in 2006 & 2007. In fact, the current level of $1.67 Trillion is well above the $1.35+ Trillion pre-recession highs.

 


I think the value investors look at the improved earnings (20%+ better than pre-recession levels) and compare it to the levels the market traded at pre-recession and see a buying opportunity. Think of it this way: the market hiccupped for 5 years now and earnings grew. You can now get in at the same level as before the recession – but you are buying an entity with 20%+ more in earnings.

Do we think this market will have legs? Well, value investors usually have a longer outlook for their investments. I don’t see them exiting the market on a whim. I think if value investors are driving this market, then we’ll likely see a higher high and higher lows. In fact, I think we could see a new higher floor in the event the market corrects backwards also. I could see our floor comfortably move up in to the $1300s for the S&P 500 – from the $1250ish level we have experienced before.

Of course, only time will tell. In the short term, the market ‘feels’ overbought on low volume. But if these ‘buyers’ were the beginning leg of value investors starting to dip their toe in the water, then expect the rally to continue. Goldman Sachs recently put an end of year target out of $1475 on the S&P 500. If you believe the value investor is behind the recent market gains, then expect that rally to continue and test the $1475 levels.

 

 



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