Sleeping Well in a Tight Market

Dave  Moenning
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Posted: Sep 27, 2012 12:01 AM

Yesterday morning we spent a fair amount of time listening to the arguments presented by the bear camp. To be sure, the list of negatives espoused by a friend and colleague was not all inclusive. I told my longtime friend that I had a deadline and that my readers don't tend to put up with more than a couple thousand words, so he agreed to keep it short and stick to the key points. And all in all, I think we did a pretty good job of offering up the glass-is-half-empty case.

However, in keeping in the spirit of the election season - where the media is supposed to give equal time (nudge, nudge, wink, wink) to both teams - I thought we should hear from the opposition today.

Given that I am a card carrying member of the glass-is-at-least-half-full club, I feel fairly qualified to present the bull case this morning. However, I do feel a need to offer up the very important caveat that my views and opinions of the market do not enter into my investing strategy. As I've mentioned a time or two hundred since I began penning my meandering morning market missive in 1999, I prefer to rely on the objective readings of my models when making investment decisions. This approach may not be right for everyone, but I must admit that the models do tend to get most of the big moves right and as a result; I tend to sleep pretty well at night.

If I had overslept and time was running short, I could probably cut to the chase and offer up just a single argument for our heroes in horns and call it good this morning. Well, okay, unless I was completely out of time, I'd likely toss in a second argument for good measure. You see, with the possible exceptions of the old Wall Street saws "buy low and sell high" and "let your winners run and cut your losses short," perhaps the two most important Wall Street-isms apply right here, right now.

The first is "Don't fight the Fed." And over the years, I have added my own take on this particular bit of Wall Street lore by adding "Especially when they are on a mission." In short, this means that when the Fed is attempting to either stimulate or slow down the economy, history makes it pretty clear that they tend to get their way. History also shows that when the Fed is trying to make things go, the stock markets (SPY, DIA, QQQ, MDY, IWM) tends to "go" as well.

This one argument alone is likely responsible for the S&P moving back toward its pre-crisis all-time highs (heck, the Smallcaps are already there). But this time around the bulls can also point to "the Bazooka" of central bank intervention that is currently being fired by not only Ben Bernanke's bunch, but the ECB, Japan (EWJ), the Bank of England (EWU), and very soon, China (FXI). (Note that the Communist Congress is happening next month where power will be transferred to a new group of leaders for the next decade. And if history is any guide, it is a safe bet that the new leaders are going to want to make an impression stat once they get the baton.) Therefore, this time around, "Don't fight the Fed" takes on a global perspective. And the bottom line is I'm not sure I want to bet against them unless things really do start going to heck in a hand basket soon.

The second argument the bulls have to offer is also an oldie but a goodie, "Don't fight the tape." This one really strikes a chord in my heart because I am, at my core, a follower of trends. Sure, I use market models and some fairly innovative trend following strategies. But the bottom line is that my goal as an investment manager is to try and stay in tune with the market's big moves.

On the "Don't fight the tape" score, it will suffice to say that the trend is up across the board. And then from a market momentum and/or internal health of the "tape" perspective, we must also recognize that although there is indeed room for improvement and there are a few nagging divergences, the "tape" is fairly healthy right now. Again, I'm not saying everything is hunky dory from a technical perspective. But it ain't bad either.

Next up on the bulls' hit parade is the idea that stocks look forward and not back. As such those wearing the rose-colored Revo's these days suggest that things are starting to look better down the road. Our bovine buddies tell us that it now looks like the "Fiscal Cliff" may meet some sort of resolution, or at the very least, be pushed out far enough so as to not send the U.S. into recession in early 2013. In addition, the bulls remind us that inflation remains low, as do interest rates. And finally, while the momentum of earnings growth has clearly slowed, we must remember that corporate earnings are either at or very near record high levels. So, unless the economy is about to stop on a dime, Corporate America seems to be doing just fine, thank you.

Then there are the cycles we talked about last week. But given that I'm quickly running out of space and time this fine morning, I'll leave you with one final argument that would appear to favor the bulls. It's called "performance anxiety" and anyone who has ever managed OPM (other people's money) will attest that this concept is very real. Cutting to the chase, if you are a manager who gets paid to outperform, you run the risk of getting fired when if you underperform for too long. And with the S&P up around +15% YTD and the average hedge fund up less than one-half that amount, I'm seeing reports of hedgies playing "catch up" by adding leverage and buying each and every dip. Thus the argument can be made that animal spirits just might push stocks higher into the fourth quarter, which, by the way, is seasonally strong.

Before I run, I do feel the need to add one more thought. Even the most enthusiastic bulls will agree that stocks are overbought and due for a pullback. As such, we were not at all surprised to see the S&P test the 1440 area yesterday. Nor would we be shocked to see a test the 1420-1400 zone should the bears find a way to keep the move that began Tuesday going. But as long as the important support holds at 1400-1420, I would suggest giving the bulls the benefit of any doubt here.

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Positions in stocks mentioned: SPY