Seven Reasons For A Bull market
Tuesday August 2, 12:55 pm ET
By Jonathan Bernstein, ETFzone Trading Specialist
After the market failed to advance last week, there have been many calls that the market is overbought and headed lower. Here are seven reasons why the bull might continue.
1. Earnings season is here, but there is no selling.
Earnings season occurs in the month following the end of each quarter: January, April, July, October. The Diamonds Trust (AMEX:DIA - News), a proxy for the ubiquitous Dow Jones Industrial Average, has fallen during every earnings season since January 2004. As the chart below shows, this trend was broken this month.
The chart above shows the DIA since January of last year. This July, the DIA has broken the trend of selling off during earnings season. Meanwhile the Standard and Poor's Depositary Receipts (AMEX:SPY - News) and the Nasdaq 100 Trust (Nasdaq:QQQQ - News), which track the S&P 500 Index and Nasdaq 100 indexes, respectively, are close to multi-year highs.
2. All main ETF sectors were up in July.
The table below shows the performance of sector ETFs in June and July:
SECTOR ETF June Performance July Performance (through 7/28)
Basic Materials XLB -2.5% 5.7%
Consumer Services IYC 0.5% 5.0%
Energy XLE 6.0% 8.1%
Financial XLF 0.6% 1.8%
Health Care IYH -0.0% 2.9%
Industrial Goods XLI -3.0% 3.8%
Real Estate ICF 4.6% 8.1%
Technology IGM -2.1% 6.9%
Utilities IDU 4.5% 1.8%
The ETFs in the table above are: Materials Select Sector SPDR (AMEX:XLB - News), the iShares Dow Jones US Consumer Services (IYC), the Energy Select Sector SPDR (AMEX:XLE - News), the Financial Select Sector SPDR (AMEX:XLF - News), iShares Dow Jones US Healthcare (AMEX:IYH - News), the Industrial Select Sector SPDR (AMEX:XLI - News), iShares Cohen and Steers Realty Majors (AMEX:ICF - News), iShares Goldman Sachs Technology (AMEX:IGM - News), and the iShares Dow Jones US Utilities (AMEX:IDU - News).
As the table shows, July performance is all black. The positivity in July has also outstripped the June negative performance. In other words, July more than made up for any losses in June. Everybody buying these sector ETFs in June and July is positive.
3. Corporate spending is picking up.
Since 2000, corporate spending has declined and savings have increased. In the last few years corporations have "de-leveraged" their balance sheets, which means they have reduced, or even eliminated, debt, and increased savings. This is generally thought to be a response to spending during the market bubble years, and an attempt to restore balance sheets. According to J.P Morgan Chase, corporations in the 2000-2004 period dramatically cut spending. Household spending has remained fairly constant. Government has stepped in and increased its spending, but as the chart below shows, in terms of sheer numbers, government spending has not fully offset corporate savings. In addition, by comparison with corporate spending, government spending is often less effective for boosting economic growth.
Change in Savings 1996-2000 (billions) Change in Savings 2000-2004 (billions)
Household -323 -296
Government 681 -982
Corporate -730 1091
Corporations, by some estimates, now hold between 10-20% of market cap in cash or cash equivalents. This historically unprecedented level of savings is equivalent to a refusal by companies to spend and has slowed ecomomic growth. What indicates that the situation is changing? First, the increasing presence of LBO firms and other private investment pools gunning for companies. Second, the purpose of corporate savings was balance sheet repair, to reduce debt, and improve profitability. Debt has been reduced, corporate profitability has improved. Third, there are signs including the recent widening of credit spreads, that corporations are starting to increase leverage again, and borrow money.
4. Technical momentum is gathering.
Technically, broad-market ETFs are at an inflection point. The Nasdaq 100 Trust (AMEX:QQQQ - News) and the Standard and Poor's Depositary Receipts (AMEX:SPY - News) are trading at the level where they began the year. The chart below shows the 52-week chart of SPY and QQQQ.
As the chart indicates, the SPY and QQQQ have been negative for the first seven months of 2005. If these ETFs can move consequently to new highs here, buyers will return.
5. Bond yields are low.
Though interest rates continue to rise slowly, with yields of around 4.25% on the benchmark 10-Year treasury note, and expectations of about 4.75% by year-end, they are not yet high enough to attract equity dollars away from investors, at least in the short run. If yields climb substantially, this may siphon money away from the equity market and pull stock prices down. If the yields climb high enough, they will eventually overwhelm equity demand. According to the Fed model, this moment still looks a long way off.
6. The al-Qaeda brand is weakening.
Ever since the London bombings, the markets have moved higher. Almost four years has passed since September 11th, and there have been no new attacks of that magnitude. Of course, there are too many targets, spread out all over too much terrain, to defend completely. There will likely be more attacks and al Qaeda remains a threat. However, the declining impact of the attacks since September 11th, and the ineffectual copycat attacks a week after the July 7th attacks in London, point to a weakened al Qaeda, whose generals are in hiding, many of whose lieutenants are dead or jailed, and whose foot soldiers are scattered and lacking coordination. al-Qaeda continues to be scary, but just not as scary as it once was.
7. Reductions in Iraq war troops.
First there were rumors, then the BBC had a story on it. Finally it made it to the mainstream domestic media. The story here is that the US will dramatically reduce the number of troops in Iraq from 176,000 to 66,000. Although specific dates and numbers are not available, this marks a fundamental change in the prosecution of the war. This news still has not received much attention in the financial press, but there is little doubt among market participants that a resolution to the Iraq conflict would be big boost for the markets.
In additional to the technical matter of the market failing to move to new highs last week, there are two large factors to watch. First, the big macro risk for broad-market ETFs is certainly higher oil. Trading above $60 a barrel, oil is showing no sign of a retreat. A second major uncertainty facing the market is the Chinese government's recent decision to make its currency, the renminbi, flexible. Although the practical impact of this change has been minor to date, further renminbi strengthening could easily have a more major impact. The psychological importance of the currency revaluation for the US markets is not yet fully understood. This could also prove important in the coming weeks.
Jonathan Bernstein, PhD has specialized in short-term trading of equities and equity options since 1998.
Email Story
Set News Alert
Print Story |
