U.S. Stocks Rally

Have you had your fill of stock market slogans? Market conditions being what they are, you are going to hear one cliché after another if you haven’t had them up to your neck already.

From “sell in May and go away” to “what goes up must come down” to “the trend is your friend till the end” and even some new ones like “don’t fight the Fed”.

Then there are the packaged theories, like “small caps lead the way”, “Dow industrials and Dow transports must move in tandem”, and all kinds of rotation theories gauging money flows out one thing into another thing until everything that means anything becomes the thing to pay attention to.

Arrgh! In the end, there is only one thing we get from all of these methods, theories, indicators or trends—a look in the rear view mirror. And who of us would ever dare drive forward while looking in the mirror? There is no substitute for sound company fundamentals.

A Market on Fire

By yesterday’s close, the Dow Jones Industrial Average closed at another new all-time high of 15,056.20, finally breaking through that neat 15K round number it had been flirting with for a week.

The S&P 500, which many believe is a more accurate stock market gauge, also closed at a new all-time high of 1,625.96, officially crossing into bull territory with its 20% rise from last November’s lows.

At a time when many felt the markets had peaked, last Friday’s jobs numbers blew yet another gust of wind into the U.S. stock markets’ sails, pushing any talk of a correction not just to the back burner but off the stove completely.

“The market is still exhibiting good karma from last week’s employment report,” Cam Albright, director of asset allocation at Wilmington Trust Investment Advisors, commented to CNBC. “Some of the news that’s coming out of Europe has been a bit more positive as well—the German factory orders report was helpful.”

“Valuations are not overly stretched either,” he added, “so from that perspective, it’s not inappropriate to add to positions.”

And the ongoing Q1 reporting season is continuing to add thrust. Of the more than 85% of S&P 500 companies that have reported to date, 67% have beat earnings expectations. At this rate, this year’s Q1 earnings are on track to beat last year’s first-quarter performance by +5.4%.

A Slow Bull Is Still A Bull

Q1 reporting has shown that while the majority of companies have beaten estimates on the bottom line (profit), their top line (revenue) growth has come in about 1% below expectation as a whole, with only 46% of companies beating their sales estimates.

Consumer credit also slowed in March for its smallest monthly increase in the last 8 months, rising by just under $8 billion where analysts expected twice that amount.

The general position is that the U.S. economy may be a little weak but is still advancing none-the-less. “What we see is a slow progress in the American economy,” famed stock investor Warren Buffett presented at his shareholder meeting this past weekend, as quoted by Bloomberg. “We’ll move forward but I don’t think we’ll be in any surge of any sort, but I don’t think we’ll stall either.”

That’s about as tranquil an outlook as you will find right now in the white hot glow of the market’s fiery furnace, with more coals being shovelled in around the world.

Recently, even die-hard “cut-spending-at-all-cost” advocates are switching sides and calling for an end to austerity in Europe. After already cutting ECB interest rates by 0.25% last week, European Central Bank chief Mario Draghi stated he is ready to do more if needed.

This support from central banks around the world has strengthened sentiment toward equities, with bond prices falling and yields rising as fixed income holders feel more comfortable putting even more money to work in equities knowing their governments have pledged to prop them.

U.S. money management firm Birinyi Associates Inc. has been bullish on U.S. equities since the last correction ended in 2009, calling for the S&P 500 to reach 1,600. Are they selling now?

Far from it. They have bought even more call options expecting the broader market index to reach 1,900 based on historical patterns first identified by Charles Dow himself, with a focus on trader sentiment over economic fundamentals.

From Bloomberg:

“Birinyi, president, and Jeffrey Yale Rubin, an analyst at the firm, wrote in the May 3 report: ‘In addition to the historical parallels, we still view sentiment as subdued and nowhere approaching extremes.’”

Cut May Some Slack

What about that “sell in May” thing? Wouldn’t this be a good time to take some profit and come back in the autumn?

Truth is, May has historically landed on the positive side. According to the 2013 Stock Trader’s Almanac, the S&P 500 monthly % changes for the month of May since 1950 have registered a total net gain of 14.1%, with an average May net gain of 0.2%. Of the last 62 Mays tallied by the Almanac (1950 to 2011) there have been 35 up Mays and only 27 down Mays.

So May traditionally has an upside bias. It is the entire 6-month span from May 1 to October 31 that as a whole underperforms the other 6 months.

Yet the pattern does not necessarily imply that markets will fall from May to October. It shows only that these 6 months as a group do not perform as well as the November to April group.

Since 1950, the November to April span has been bullish 48 years compared with only 14 years bearish, while the May to October span has been bullish 37 years compared with only 25 years bearish.

Both 6-month spans are net bullish. Markets have an overall bias to rise over time.

[If anything, only 4 months of the year need cause concern: August in 4^th place (total net loss of 2.4%), June in 3^rd place (total net loss of 4.5%), February in 2^nd place (total net loss of 7.4%), and September in 1^st place (total net loss of 35.4%). The other 8 months are all net positive, with May in 8^th place and December in 1^st place, based on S&P 500 data from 1950 to 2011.]

Stick With the Solids

Indeed, over time markets keep rising. Of course, there will be those temporary corrections from time to time, which can strike in any month. This is healthy to prevent the locomotive’s boiler from exploding. You have to let the excess pressure out once in a while. And we may be due for just such a release soon.

To protect one’s portfolio from those periodic releases of excess steam, traders need to pick their stocks carefully. Warren Buffet likes companies with low valuations and plenty of cash flow, and to say it has worked for him is an understatement.

Others like value stocks with shares trading below book value, while still others who do not necessarily trust their stock picking skills prefer to go with sectors as a whole. During corrections and those summer-time “less bullish” 6-month spans, defensive sectors like consumer staples (companies that provide the necessities of life) tend to outperform consumer discretionaries (companies that provide the non-essentials).

If you are not the type to jump on and off of every band wagon driving up the street, you might simply pick something you are comfortable holding year-round, adding a little on the dips and pocketing some profit at the peaks.

However you choose to approach the markets today, remember that these are unprecedented times, with central banks around the world all doing the same thing at the same time—pumping money into their economies and keeping interest rates ultra low. We can expect markets to do unprecedented things.

However, traders should never abandon sound investment planning. Market trends change all the time, but wise investing never does. Buying into the three hallmarks of quality stocks—namely stability, diversity and prosperity—will help any portfolio ride out the rough spots and continue soaring on the winds of good fortune.

Joseph Cafariello

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