Market Commentary – February 16, 2010

General Market Comment:    February 16, 2010

 There has been the most talked about and fretted over minor correction in the market in recent memory since I last commented on the market.  The S&P 500 is down by 6.5% from its 52 week high and is down 3.6% year to date.  The NASDAQ is down 6.1% from its 52 week high and by 3.8% YTD.  By all the press you would have thought we were in a complete free fall – like last year.  The data – as I read it – seems to suggest this episode of selling may be nearly over.  Without taking up too much of your time, I will comment on three items from which I draw comfort and support for my view point.

 The first is earnings . . . lots and lots of earnings.  As you all know we are in the midst of the Q4 earnings season.  So far – it’s a barn burner.

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73% of the reporting companies in the S&P 500 have beaten estimates.  This compares with a normal “beat rate” of 61% as per Thomson Reuters.  You can see on the chart to the left from Bespoke Investment Group ( ) just how this beat rate stands out . . . of course it may lose some steam in the coming weeks but this rate of out performance is consistent with rising stock markets.

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Over 70% of the reporting companies in the S&P 500 have beaten revenue estimates.  You can see on the chart to the right, also from Bespoke, just how this beat rate stands out . . . again, this rate of out performance is consistent with rising stock markets.

 Many people are distressed that the consumer is cash strapped and deleveraging.  The belief is that since the consumer sector is 66% +/- of the economy that the economy can’t grow and therefore the stock market can’t appreciate.  Like most simply put hypotheses, this one may be simply incorrect.  Mind you I am not contending that the consumer is not strapped or is not deleveraging.  I only wish to point out that the stock market discounts earnings and hence if earnings are growing then the stock prices of those companies with sustainable growth in earnings will appreciate even if the consumer sector is stressed.  Have a look at the following table from Thomson Reuters from last week.  I want you to notice the composition of the earnings of the S&P 500.  You may discover that the earnings from technology far exceed the earnings from consumer staples.  Tech earnings are also growing 50%.  The point I wish to make is that the stock market will reward growing companies – such as tech companies – and that a growing tech sector and rising stock values are NOT mutually exclusive with a stressed consumer. 

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 The second item I wish to bring to your attention is the extreme level of bearishness in the market.  Extremes in sentiment are thought to be good contrary indicators.  If everyone is scared and bearish – its time to be bullish.  The folks at Bespoke once again were kind enough to produce an effective chart illustrating that the bullish sentiment, as represented by Investors Intelligence, is the lowest i.e. most discouraged, since March 2009 . . . the panic bottom for the market.  It also dipped sharply right at the bottom of the other minor correction the market has experienced in the latest recovery back in July.

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 The third item I wish to point out is another contrary indicator.  I want you to have a look at the final numbers for net inflows to equity and bond mutual funds for 2009.  The amount of money that ran away from stocks in 2008 and ran to bond funds in 2009 is astonishing! 

ScreenHunter_10 Feb. 16 10.56 

There has NEVER been as much money paid into any type of mutual fund in any single year as went into bond funds last year.  The amount almost exceeds the cumulative inflows to bond funds for the prior 7 years!  No wonder the guys at PIMCO are always smiling – if this is the “new normal” I am sure they want more of it as they go pick out their next new Gulfstream jet.

 Of course – sadly – the move is HIGHLY predictive of a top in the bond market and a relative low in the stock market.  History tells us that you should take the opposite bet from the retail mutual fund investor.  The only other episode that approximates such an extreme surge in inflow was the flood of money into equity mutual funds at the very top of the tech bubble in 2000.  The pendulum will swing and the odds on bet is that equity funds will be the beneficiaries.  If $100 billion were to go back into equities – not an outrageous call – you could expect a gearing to 10X to 15X in the aggregate market cap.  This suggests that market value could grow by as much as $1.5 TRILLION.  The implication is a 10% +/- jump in aggregate market cap.  Just such a move happened in 2003 and 2004 . . . the last time we had an earnings recovery similar to what we are now experiencing.

 So . . . as I said in January . . . we have a sufficient number of energetic and vocal skeptics to prop up the proverbial “wall of worry” needed to sustain a bull market, a looming pile of catalytic data in the form of Q4 earnings reports, plenty of cash still poorly invested . . . that all seems to suggest we have more risk to the upside in stock market values in the near term”.