5 Reasons Why the Market Will Strengthen From Here

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The old axiom "The stock market always looks ahead" remains in force. And as is often the case, market forecasters are all over the lot as to what we can expect in 2011, 2012 and beyond.

The most bearish forecasters can reasonably cite a bearish consumer, stressed federal and state governments, and trading partners that have major economic concerns of their own. But it's important to remember that in times of fear, those bearish pundits get plenty of attention and their bullish counterparts may seem out of touch with reality.

So in the trade-off between all of the positive and negative forces in our economy, the positive factors in play might be getting short shrift. Here's a quick look at five factors that could push the stock market onto a nice growth path

1. Profits = Cash = Jobs
Corporations are a fairly predictable lot. They react to economic downturns and upturns in a repeated fashion. First, they cut jobs. Then, they generate higher profits thanks to now-smaller workforces. As those profits pile up on the balance sheet , they post abnormally high levels of cash. Finally, when convinced that the worst has passed and they have tired of over-burdening shrunken workforces, they begin to re-hire lost employees. Eventually, unemployment shrinks and consumer spending rises. This is precisely how things played out in the 1990s, with very positive results for investors willing to stick it out through the lean years.

2. A long, long way from onerous interest rates
The cost of borrowing remains near an all-time low as the Federal Reserve keeps inter-bank lending rates barely above zero. The Fed is likely to keep rates low for some time to come. When the Fed finally begins to raise rates -- perhaps some time in 2011 -- they will go slowly and may simply move rates back up 300 to 400 basis points, a level which should still be conducive to economic growth and a level that should still make equities comparatively attractive relative to fixed income plays.

3. The global consumer
Lost in all of the hand-wringing about global economic problems has been the stunning rise of a consumer class in Chile, Brazil, Korea, China, India and elsewhere. Those countries alone account for more than half of the world's population. And if history is any guide, markets with fast-rising middle classes (such as Japan in the 1970s) tend to drive demand for global brands. Executives at firms like Coca-Cola ( KO ) , IBM ( IBM ) , Walmart ( WMT ) and Procter & Gamble ( PG ) have been busy establishing beach heads in those newly-robust countries, and should become dominant brands in these newer markets.

Brazil in particular is a great story -- the country is in the process of lifting its neighbors through direct investments and increasing trade flows. Conveniently for us, major Latin American markets are just a direct flight away.

4. M&A and private equity give benchmarks
We've seen a reasonable amount of deal-making in 2010. More than we saw in 2009, when everyone was gun-shy, but perhaps less than what many forecasters had expected.

The healthcare industry -- especially biotech -- has accounted for the lion's share of deal-making in recent quarters. But as the economy stabilizes and companies realize that organic sales growth is muted, we might see a robust uptick in mergers and acquisitions (M&A) in other sectors as well -- that is, if the private equity ( PE ) shops don't beat them to it. A lot of these PE firms raised oodles of money three or four years ago and are bumping up against deadlines that compel them to put that cash into play or return it to investors.

All of these deals are very helpful for investors, as they establish an appropriate value for businesses and industries. Hypothetically, if a company is bought for 20 times trailing earnings and its rivals are trading at 12 times earnings, you can bet that investors will flock to cheaper rivals in search of the next hot deal.

5. Buybacks
For companies sitting on lots of cash (see Reason #1), but have no interest in doing a deal (Reason #4), then stock buybacks become a real option. We're already seeing companies as diverse as Hasbro ( HAS ) , DirecTV ( DTV ) and Cisco Systems (Nasdaq: CSCO) buying back gobs of stock. Until and unless the stock market really zooms ahead, look for an increasing number of companies to announce large buyback programs, which can be a real boon for per share profits. For example, since 2005, Home Depot ( HD ) has reduced its share count from 2.2 million to 1.7 million. That -23% reduction in the share count means that earnings per share ( EPS ) is +23% higher -- on the same amount of net income .

Action to Take --> This is no time for complacency. Risks remain and investors may want to lock in profits on any fast rallies. But whenever we get a stock swoon as we saw in June, keep reminding yourself of all of the positive factors that can be easily forgotten.


-- David Sterman

David Sterman has worked as an investment analyst for nearly two decades. He started his career in equity research at Smith Barney, culminating in a position as Senior Analyst covering European banks. David has also served as Director of Research at Individual Investor and has made numerous media appearances over the years, primarily on CNBC and Bloomberg TV. David has a master's degree in management from Georgia Tech. Read More...

Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.


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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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This article appears in: Investing , Stocks


David Sterman

David Sterman

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