Shutterstock photo

5 Reasons to be Optimistic about the Stock Market

Shutterstock photo

Shutterstock photo

Back in late April, I cautioned that summer trading can be quite tricky , noting that May is a good time to take profits because the market often weakens in June and July. Little did I know that the "summer swoon" would actually start in May. Since hitting a recent peak in late April, the S&P 500 has lost ground every week for six straight weeks. And a quick look at the economic landscape may lead you to conclude that further market downdrafts lie ahead. (As I recently noted , there are a number of powerful economic headwinds that could really spook the markets.)

Yet some contrarian investors see an entirely different picture. They tend to distrust market rallies, but they also know that periods of gloom and doom actually present buying opportunities because investors tend to conflate short-term challenges with long-term catastrophes. After all, the economy looked to be getting steadily weaker in the summer of 2010, causing stocks to slump through August. But within a few short months, the economy looked healthier once again and the market rallied nicely higher into the winter -- the S&P 500 rose 28% from August 31, 2010 to February 17, 2011.

For investors that find it hard to believe that times are getting tougher, here are five potential positives that could help stocks move back higher in coming months.

1. The Japan-related slowdown improves

A number of recent economic reports have pointed to a slowdown in the manufacturing sector, with many companies noting that Japan's work stoppages after the tsunami/earthquake led to parts shortages throughout the global supply chain. Japanese manufacturers are starting to ramp up production again, and those supply chain issues should recede over the course of this summer. That could help U.S. manufacturing to resume the upward trajectory it had been on for much of the last 18 months.

2. The Biden factor

He's an eternal optimist, but Vice President Joseph Biden thinks increasingly constructive talks about the massive budget problems are taking place during the bipartisan meetings he is chairing. This coming week should see a stepped-up level of dialogue heading into the July 4 Congressional recess. If a deal can start to take shape, then a big overhang on the market would disappear.

3. Individual investors are always wrong

Last August, as the stock market was drifting ever lower, I noted that individual investors had turned bearish -- which is always a positive for stocks.

Guess what? They're bearish again. In the most recent survey conducted by the American Association of Individual Investors, bears make up 43% of surveyed respondents, while bulls make up just 29%. This is a modest improvement from the prior week, when only 24% of respondents were bullish, but it still represents one of the most bearish periods of the year. Keep an eye on this survey. If bullish sentiment drops below 25% once again, it would be an unmitigated signal to buy stocks.

4. A return to M&A

When an economy starts to cool, so does the talk among dealmakers. Economic uncertainty is just too risky for many executives to make bold moves. But if the economy stabilizes in coming weeks and months, then those same executives are likely to revisit any possible acquisitions they may have been mulling. And the market likes M&A activity. It provides a clear sense of private market valuations for stocks, highlighting which stocks and sectors may be undervalued. With so much cash parked on corporate balance sheets, we may be headed for a peak of deal-making in coming quarters -- if the economy obliges.

5. Thebond market's dimming appeal

One of the key strikes against stocks is that bonds have seen so much interest among investors. Bond funds have been continually attracting inflows (news money coming in) while domestic equity funds keep seeing outflows (money being pulled out). But the time is getting closer for the Federal Reserve to start to hike interest rates. This means bond prices would fall and yields would begin to rise as a result. This is why some think we're near the end of the multi-decade rally in bonds, and a shift into other assets may be the next move. Might stocks be the beneficiary of all the liquidity sloshing around global markets?

Action to Take --> The key takeaway is that stocks are feeling the heat of a string of sobering economic news. Yet it's no sure thing that the slowdown will result in a double-dip recession . The U.S. economy has often proven to be more resilient than many have expected. While a cautious stance is merited, you need to keep any eye on what could go right as well.

Retail stocks have been especially hard hit during the spring swoon, and valuations are quite reasonable. If signs that consumer spending can stabilize and even strengthen just a bit in coming months, then retail stocks will move back into favor.

The Amex AirlineIndex (AMEX: XAL) has fallen from 50 to 40 since last November, due to rising oil prices. A recent decision by Saudi Arabia to pump more oil could help push oil prices back down, breathing new life into the airline sector.

-- David Sterman

P.S. -- Few investors realize that a 20-year energy agreement between the United States and Russia is about to expire. This deal supplies 10% of America's electricity. As broke as our government is, the situation is so serious that President Obama is asking for $36 billion to avert this crisis. And Republicans support him. Here's what's going on…

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

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

© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.

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