@ Zacks : 6 reasons to be bullish

6 Critical Issues for the Market
by Mitch Zacks, Senior Portfolio Manager



According to a recent American Association of Individual Investor's survey, 55% of individuals expect the market to fall over the next six months. This is the largest negative proportion seen since mid-2010. Personally I see this as a bullish sign.

Nevertheless, this survey comes as no surprise to us as there are currently several headwinds in this Fed-driven market. Today, we will discuss 6 issues critical to the future of the market and where investors can find opportunities.


1. Europe

Europe is the biggest headwind facing the market today. We are forecasting a European GDP decline of -0.2% for 2013. Effectively, Europe is heading toward a recession in the coming months. There continues to be a framework of risk, an economic slowdown, and bank solvency issues in place in Europe.

Europe also has issues to deal with including Cyprus and massively high unemployment. We believe most of these problems will be played out regionally and will not spread on a global scale. Despite this it is hard, without a pan-European stimulus measure materializing, to be bullish on Europe. Right now, the U.S. provides greater opportunity.

We recommend investors should continue to rotate out of European equities into U.S. equities.


2. A Positive Feedback Loop From The Central Bank

When financial markets collapse, data is bad, and economies are faltering, there is a prescription taught to all responding economists that policy overreaction is the answer. Over-reaction by the Federal Reserve and the Bank of Japan are the latest, glaring examples. Investors need to understand this positive over-reaction feedback loop.

The Fed first began using the financial markets to start a positive loop in 2009. They wanted to build balance sheets up, improve consumer confidence, and increase spending and GDP growth. The program has been working so far. To insure this loop continues and strengthens in 2013, the Fed is now over-reacting. 

The key question for this stock market is whether or not the quantitative easing over-reaction continues, or is tapered back. Another year of this type of regime is likely in the game until at least 2014.

Therefore, we believe this positive feedback loop will continue to have a positive effect on asset prices in the U.S. and other countries where there is a large quantitative easing program such as Japan.


3. Private Lending Not Picking Up 

Because of the low interest rate environment, banks are not able to charge higher interest rates on consumer loans or mortgage loans. In other words, banks are making less on the money they loan out.

As a result, private lending to businesses remains relatively weak. Major U.S. banks are keeping their share prices up by cutting headcount and reducing expenses instead of increasing their loan activity. 

The Fed's hoped-for handoff to the private markets from the public markets is not happening yet. We are not seeing enough new U.S. businesses or new U.S. investment in old businesses. We need the banks to step up in the next leg of this recovery.


4. China

The Chinese inflation reduction program is a big issue to watch in Asia.

China's economy is growing at 8% annually. However, the central authorities are crushing the Chinese housing real estate market. These central authorities do not want an asset price bubble moving ahead and taking control of their economy like we saw five years ago in the U.S. 

It is important to remember that China has 1.3 billion people. Experiencing 5% inflation is not acceptable. If prices rise too fast and there are tens of millions of poor Chinese workers that can't buy milk and food, then this will create social issues the authorities desperately want to avoid.

The Chinese policies are not likely to have much of an impact here in the U.S., but they are likely to be a benefit to Japan.


5. U.S. Corporate Earnings

The Fed's quantitative easing is going straight to the consumer. U.S. consumers are becoming wealthier from higher stocks prices and home values. 

This should continue to benefit consumer stocks, specifically domestic, small cap consumer stocks. In other words, we believe investors should stay with consumer stocks because the Fed wants to increase their spending. 

This should have a positive effect on U.S. corporate earnings, and in this environment, earnings estimate revision models are likely to be a good predictor of stock price movement.


6. U.S. Interest Rates 

Interest rates are not likely to go anywhere in the near term. The Fed has made it clear that they intend to keep rates low for some time. It is our belief that investors should not "fight the Fed". 

The Fed is trying to get investors to step up the ladder of risk. Institutional investors have been forced out of cash to the next rung of risk, and individuals are likely to follow. This should be a positive to equities, especially low risk equities including high dividend yielding stocks. 

In this scenario, it is not a good idea to have too much money in cash or over allocate to fixed income investments. However, dividend paying stocks should continue to outperform in a low interest rate environment.


Putting It Together

In summary, a confluence of different themes has become evident. These themes are complementary. Earnings growth, as a result of the quantitative easing, should benefit domestic small cap stocks with a consumer focus. Low interest rates should benefit dividend yielding stocks. Economic problems still remain in Europe and China, and therefore the U.S. remains the most attractive investment. 

Together, such themes may keep the overall stock market up.

April 21, 2013.