Making Sense of This Market - Weekend Wisdom

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You have seen the headlines - stocks are at all-time highs.

The market had a choppy start to 2014, but appears to have found its groove lately. The S&P 500 index has moved past the 1900 level and many investors have started looking at the 2000 level as the next target.

Most investors are quite bullish as they see the current uptrend continuing on the back of improving fundamentals and diminishing risks. Others are not so sanguine and cite the sub-par corporate earnings picture and other macro challenges coming the market's way.

These contrasting views beg the question of where we go from here. And that's my goal in this piece - to survey the landscape of bullish and bearish arguments to help you make up your own mind.

Towards the end, I share a robust investment framework that you can rely on irrespective of whether you lean one way or the other in this debate.

Let's talk about the Bull case first:

1) The Negatives Are Already Priced In: This means the sum total of all bad or negative news about the U.S. and global economy is already well known and reflected in current prices. It seems quite plausible since questions about the Fed, the outlook for the U.S., China, the Euro-zone and Ukraine have been around for a while now and are no longer 'news' to any market participant.

2) Economic & Earnings Pictures Quite Healthy: The unusually harsh winter this year pushed GDP growth in the negative in Q1, but the picture has turned around with the Spring thaw and growth is expected to exceed +3% in the current period. The resumption of growth in Q2 is expected to ramp up into the back half of the year and continue into next year. The corporate sector is in excellent shape, with total earnings in record territory and growth expected to notably improve going forward.

More . . .


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3) Central Bank 'Put': The U.S. Fed's QE program is coming to an end, but the overall monetary policy stance across all the major economies, including the U.S., remains favorable and supportive of the market. What this means is that the market has great confidence in the Fed's ability to keep short-term interest rates at the current near-zero level for a very long time.

Let's see what the Bears have to say in response:

1) Market Is Pricing a Best-Case Scenario: Market prices reflect consensus expectations, and current consensus expectations for GDP and earnings growth are clearly on the optimistic side. Europe has no doubt stabilized, but the region will likely continue to struggle for a long time. The situation isn't that better in China either, where the best-case scenario is a stable economy that will grow at rates significantly lower than what we saw in the past decade. The rest of the BRICs appear to have hit a wall as well, which is having knock-on effects all over the world. It is way too optimistic to assume that the U.S. economy and corporate sector will remain immune from the negative forces swirling all around.

2) Economic & Earnings Pictures Far from Healthy: It's shocking to see that the largest and most diversified economy in the world can be pushed into negative territory by harsh weather alone. I am ok with blaming everything bad on the snow and can appreciate the nice rebound in activity levels in the current period. But I find it hard to buy into the consensus narrative that the U.S. economy is on the cusp of graduating to an above-trend growth in the coming quarters. The story isn't much different on the earnings front. Yes, the level of total earnings is very high, but there is not much growth and the consensus hope of a growth ramp-up in the second half of the year is likely nothing more than just a hope.

3) The Bond Market Divergence: The rosy consensus outlook for the economy and earnings has convinced investors to pile into stocks, pushing the broad market indexes into record territory. But the bond market isn't buying that outlook. As a result, bond yields are bucking conventional wisdom and coming down in the face of overall positive economic data. Stock market bulls are hanging on to weak arguments that limited bond supply and Ukraine-related safe-haven trades to explain the downtrend in bond yields. But the most logical explanation is the bond market's skepticism of the consensus economic outlook. The bond market isn't infallible; it has been wrong in the past. But it has an overall better track record in foreseeing which way the economy is headed than the stock market.

Where Do I Stand?

As regular readers know, the bearish case makes more sense to me than the alternative. Simply put, I find it hard to envision stocks holding their ground in the current sub-par corporate earnings backdrop. The market hasn't paid much attention to the persistent negative earnings estimate revisions over the past year or so, likely on the assurance of continued Fed support. But with the Fed on track to get out of the QE business in the not-too-distant future, they have to start paying attention to corporate fundamentals.

Keep in mind, however, that being bearish doesn't mean that you have to exit the market altogether. There is always an opportunity to make money somewhere in the market. You could go long when you feel bullish or go short when things don't look so reassuring, or you could load up on defensive stocks or get more aggressive. Keep in mind that you are not restricted to the domestic market as you can always diversify into international markets when opportunities warrant.

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This Monday's Zacks Confidential email offers an exciting way to approach the current market. You can get in on its recommendations ahead of a lot of other investors if you look into the program right now.

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Sheraz Mian

Sheraz is Zacks' Director of Research and runs our long-term Focus List that registered the 2nd best performance of any newsletter portfolio over a 15-year period. He also runs the Zacks Top 10 which has substantially outperformed the market over the past year with a +46.5% return. You will often find his recommendations featured in Zacks Confidential.

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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 Nasdaq, Inc.

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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