5 Reasons the Market Could Rally Before the Year Ends

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Shutterstock photo

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Here we go again. This week is starting off where last week ended -- on a dismal note. Since hitting an intra-day peak of 1,346 back on July 22, the S&P 500Index is on track (as of Aug. 8) to mark its 10th losing session in the last 11.

This kind of sustained sell-off has few parallels in history and can be explained away by one simple fact: There are few reasons to buy stocks now and ample reasons to sell them. The U.S. economy is weakening, the ongoing European crisis is showing no signs of ending, and massive projected U.S. budget deficits go largely untouched (despite the recent cosmetic efforts in Washington).

In effect, the market is in "Murphy's Law" mode: Anything that can go wrong is going wrong. Economic woes in United States, Europe and Japan, which collectively account for much of global economic activity, are bound to deepen as consumers retrench further, companies lay off more workers, government paralysis deepens and the risk of an exogenous shock to the financial system heightens.

Then again, maybe not...

It's simply too soon to know how this plays out and draw such dire predictions. For every risk that lies out there, an alternative, brighter factor may took root instead. This is why the next five months of 2011 are so crucial. These current crises will either snowball, justifying the recent market plunge, or signs will emerge that the sky is indeed not falling, and this could kick off a powerful rebound rally.

Let's look at five items that could spin positive for the market...

1. Major headwinds start to abate and companies begin to hire

We've been waiting to see employment levels rebound and start to lead a broader recovery. Yet since the year began, the Arab uprising has sent oil prices higher, the earthquake in Japan led to a sudden slowdown across global supply chains, U.S. budget talks created the real chance of a government default and repeated attempts to solve the Greek debt crisis failed to bring a permanent resolution. So much for plans to make investments ahead of an economic rebound.

Yet if the rest of the year is simply boring and we can avoid any further exogenous shocks, then corporate America, which is sitting on mountains of cash, may start to bolster strained workforces. This would kick off a virtuous cycle because rising employment creates more free-spending consumers. Suppliers of consumer goods would in turn need to boost output to re-stock very thin supply chains, creating their own hiring gains in the process.

2. The post Arab Spring reality

Unless events in the Middle East broadly weaken, oil prices have likely seen their highs for the year. Indeed, the recent pullback to $84 (per barrel) oil may have not fully run its course as the prospects of lower GDP growth rates this year, coupled with a possible resolution in oil-producing Libya, could push oil toward $70 eventually. Gasoline prices are now falling, and as they fall further, consumers will feel just a bit better than before.

3. Wheeling-and-dealing

Deal-making on Wall Street always been a boost for markets because it provides investors with a clear sense of private market ( PM ) valuations. Often, the PM value is higher than the public value, which is why buyouts typically come with a hefty premium. Of course, deal-makers hate economic uncertainty (for fear of simply inheriting someone else's mess), which is why we've seen few major deal announcements in recent months. Yet if the global economic picture gets quieter in coming months, devoid of earthquakes, bond crises, budget crises, social uprisings and, yes, major hurricanes, then deal makers will take advantage of the quieter times to help companies buy their way into growth in these slow economic times.

4. Balance sheets to the rescue

In the past few years, as the market was posting a sharp rebound from the 2008-2009 lows, companies were buying their stock back at a very aggressive pace. Trouble is they were often buying backshares at 52-week highs, which is usually not the best way to get a return on that investment. Stock prices are now far lower at many companies, even as many of them still sport mountains of cash and are throwing off ample cash flow . So unless companies get really spooked by all of the global economic chaos, look for major stock buybacks to keep rolling in. The chance to materially lower the share count in these tough times sets the stage for much improved per-share profits when the economy rebounds.

5. The weak dollar play

Nissan this past weekend it has decided to cut output due to the painfully high Japanese yen. The Japanese government tried to weaken the yen through open market intervention last week, to little avail, and it increasingly looks like a strong yen is a fact of life. What about the euro? The problems at the PIIGS (Portugal, Ireland, Italy, Greece and Spain) have kept the currency quite weak on fears of an escalation in the crisis. If the crisis doesn't deepen and instead stabilizes, this could help the euro to find its footing and resume its upward trajectory that was underway before the crisis of 2008 hit.

A strong yen, a stabilized (and perhaps rising) euro, and the continued glacial strengthening of the Chinese yuan,mean one thing. The dollar could lose ground anew, which is what should be happening when a country runs fiscal and trade deficits. A weakening dollar (as long as it takes place in an orderly fashion) would be so good for the U.S. economy, starting with job creation back home, rising repatriated profits from abroad and an improved competitive position for U.S. firms against foreign rivals.

Action to Take --> Are all these positives likely to kick in straight away? Surely not. The market is still digesting all of the recent bad news. Yet once this near-term process plays out, look for many investors to take note of the very-cheap multiples sported by many U.S. Blue Chip companies. They'll also likely begin to take the view that the economic picture has some real positives buried among all the negatives.

-- David Sterman

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.

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