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6 Reasons The Market Could Rebound

 June 01, 2012 01:29 PM


(By David Sterman) If you've been a regular reader of my articles during the past four months, then you know how much I feared the eventual market rout we're now witnessing. I only mention this to make it clear that my current, increasingly bullish view is not a case of blind optimism. And frankly, I think we're getting a lot closer to the end of this brutal market than many realize. 

Predictions that we'll revisit the lows of early 2009, as I noted in this article, simply seem to be too alarming. In many respects, the U.S. economy is in a very different position than it was back then, and a host of positives are in place to help stocks find a floor -- sooner rather than later. 

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As I write this, the S&P 500 is off nearly 10% since late March, which typically signals a correction. Here are six reasons why the current market may bring out the buyers instead of even deeper waves of selling:

1. Earnings are holding up well. 

Just one month ago, we were marveling at the robust level of first-quarter profits. Companies have maintained such a tight lid on costs that they are largely posting profit margins at or near record levels. The fact that the first quarter of the year was largely solid for many companies -- even as Europe was tumbling into recession -- is nothing short of remarkable.

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2. Balance sheets are strong.

As the market weakens, you can imagine the conversation going on across many corporate boardrooms: "We've got so much cash that we ought to defend our stock with buybacks and dividend hikes." 

We've already seen a noticeable uptick in insider-buying in recent weeks, and if the market stays weak into July, then look for a surge in buyback and dividend announcements.

3. The United States is an asset magnet.

Across the globe, fund managers and high-net worth individuals are watching Europe crater while China (and the rest of Asia) slows. In this context, they're increasingly seeing the United States as a safe haven. The U.S. economy will surely feel the pain of a global economic downdraft, but is still likely to grow at least 2% in 2012 and 2013. And when the global drag abates, U.S. gross domestic product could well move onto a higher plane as we move into the middle of the decade. That's why global money managers will likely flock to U.S. stocks as they lighten their equity exposure elsewhere.

4. The hatred of stocks runs deep, part 1.

History has shown that stocks tend to do well when individual investors turn very bearish. The latest reading from the American Association of Individual Investors (AAII) implies that 28% of investors are bullish, but the survey was completed before the sobering monthly employment report that came out on June 1. Chances are the bulls will drop below 25% in this next report, which has historically been a clear "buy" signal.

5. The hatred of stocks runs deep, part 2.

Strategists at Merrill Lynch conduct a monthly survey to gauge how other Wall Street firms are feeling about stocks. They measure the suggested percentage of a portfolio that should be tied up in stocks. And right now, Wall Street is deeply concerned. Merrill Lynch's gauge of professional investor sentiment has now dropped in eight of the past 10 months -- to the lowest level since 1997. Merrill's take: "Given the contrarian nature of this indicator, we are encouraged by Wall Street's lack of optimism and the fact that strategists are recommending that investors significantly underweight equities vs. a traditional long-term average benchmark weighting of 60-65%."

Merrill's analysts make a pretty clear case of why investors should find stocks appealing when the crowd is running away. "Historically, when our indicator has been this low or lower, total returns over the subsequent 12 months have been positive 100% of the time, with median 12-month returns of +30%," they say.

My take: pay attention to the wording "subsequent 12 months." Stocks could easily weaken from here, but there's a very good chance (in this case 100%, using historical data) that stocks will eventually rebound well above current levels.

6. Pump priming is coming.

From China to Europe to the United States, policy makers are gearing up for a major push to revive their respective economies. In China, this means regulatory streamlining to boost investment. In Europe it means a fresh strong package of banking sector supports will be implemented, which will likely remove the "sky is falling"-type fear from the markets. In the United States, it means more liquidity injections from the Federal Reserve in the next round of Quantitative Easing (which could be announced when the Fed meets in a few weeks). 

Risks to Consider: We still haven't seen "capitulation day" when the stock market falls 3%, 4% or even 5%, which typically signals the end of a correction. We may never get such a move, but you need to be prepared for such an eventuality without having your faith shaken. Selling at lows is a sure-fire way to underperform the market over the long haul.

Action to Take --> The market gets ever weaker, and on a company-specific level, deep values are emerging. In coming days, I'll be running a series of screens to find the deepest values in this market, whether it's in terms of balance sheets, cash-flow statements, insider-buying or a host of other measures. If you don't have cash to work with right now, then this is a fine time to sell your most richly-valued stocks that have held up fairly well in this market.


-- David Sterman

David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.


This article originally appeared on StreetAuthority
Author: David Sterman
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