Posted by Shyam Moondra
The DJIA is ready to crack the 15,000 mark this week or next for the first time in history and short sellers are scratching their heads. Since the market hit a low of 6,443 in March of 2009 at the height of the financial crisis, it is now up by 130%, making it one of the strongest comebacks ever. The bears, who thought an impending crash was a sure bet, are totally confounded at the resilience of the market.
I have written about the unfolding market story and predicting a long-term bull market that will take us to the 18,000 mark on DJIA by the end of 2015 (“We are in a secular bull market – DJIA headed to 18,000,” March 4, 2011; “Market impediments dissolving – DJIA headed to 18,000,” February 21, 2012; “Analysts behind the curve – market entering a major bull phase,” March 16, 2012; and “Bull market continues – DJIA headed to record high,” January 1, 2013). The current market conditions only reinforce my prediction.
It’s worth noting the following trends:
• When market goes up big (100+ points) with heavy volume several days in a row, exhibiting "irrational exuberance" (a term coined by former FED Chairman Alan Greenspan), it is usually a sign that the market has peaked. However, this is not what is currently happening; the market has been going up sluggishly with light volume, which means that it has a long way to go before we see a major correction.
• The current market rally is unusual in the sense that “not-so-sexy” stocks (such as Pfizer, Merck, Microsoft, IBM, Verizon, Coca-Cola, etc.) are going up but many industrial and financial companies (e.g., Alcoa, Bank of America, Citigroup, Caterpillar, Exxon Mobil, Apple, Dow Chemical, etc.) have not yet participated in the rally. This unevenness actually sets the stage for rotation and a continued bull run in the near-term.
• The corporate earnings are at record levels, thanks to their masterful management of their cost-structures and cautious capital expansion, which, of course, explains a slow pace of improvement in the job market. The corporations have one of the strongest balance-sheets ever, with $4 trillion of cash pile that will fuel further capital expansion and job creation in the coming months and years.
• The housing comeback, healthy auto demand, and surprisingly strong energy sector are contributing to economic recovery.
• We continue to enjoy an environment of low interest rates and low inflation that is usually ideal for market rallies.
• Increasing housing prices and higher stock prices are creating the wealth effect which would encourage consumers to spend more and thus continue to fuel the economic recovery.
• Many analysts view impending winding down of FED’s QE 3 as a catalyst for the market crash. If the FED does this gradually, all in all, we will actually see a stronger market for two reasons: first, the stimulative effect of QE 3 is unleashing economic expansion which would easily absorb the gradual unwinding of QE 3 and, second, as the interest rates go higher, the bond bubble will finally burst and some of that money will move to equities and thus keep the stock market rally going.
• Finally, based on historical standards, the current stock valuation is very attractive. WSJ reports that the trailing PE ratios based on operating earnings (i.e., excluding one-time extraordinary items) are as follows: DJIA 13.05, S&P-500 14.10, and NASDAQ-100 15.00. These ratios are, by no means, excessive (at the last market peak, these ratios were in high-20’s to low 30’s). Given that the economic growth is slower now than in the past, we may not see that high PE ratios any time soon, but from current levels the market could easily go up by 20-30% before beginning to look pricey.
Yes, as the market goes up, there will be intermittent profit-taking which will cause small corrections along the way, but a major bear trend is not in the cards, as yet. In fact, in the current bull run, we could witness one of the strongest short squeezes we have ever seen.
