Stocks Cruise Along, Whistling Past The Graveyard

 | Jun 23, 2014 03:13AM ET

U.S. stocks just continue to cruise right along, although investors seem to be displaying a healthy level of caution, looking over their shoulders as they whistle past the graveyard and bet on ongoing improvement in corporate earnings and economic growth. Despite extremely overbought technical conditions and regional hot spots that may ultimately threaten global economic recovery, investors seem undeterred. Indeed, all major central banks are now onboard the liquidity bandwagon, and although bonds have not sold off as many expected (to create a Great Rotation into equities), most income and total return-seeking investors in the U.S. see little in the way of attractive alternatives to equities.

The economic data continues to indicate improvement in the U.S. economy. For example, the number of job openings waiting to be filled in the United States rose in April by 289,000 to 4.5 million, which is the highest in nearly seven years. This bodes well for an imminent fall in the unemployment rate. Also, April retail sales were revised upward to +0.5%.

Furthermore, the global economy seems to have the wind at its back, thanks at least in part to central banks around the world providing a sea of liquidity by printing money. The scary side of this is that when the next recession eventually arises, all of these central banks will be low in ammunition to fight it. Nevertheless, for the near term, it seems that all is well for U.S. stocks, even though fears of a major crisis continue to push much of the global liquidity that is being printed into U.S. Treasuries in a flight to quality and safety. The U.S. 10-Year Treasury yield remains quite low and may yet fall further.

With economies in Europe and the U.S. improving, China has been able to grow exports and expand its trade balance. In addition, China has enacted a number of policies to support the housing market and overall economic growth. All of this seems to have staved off the brewing crisis there.

Of course, there is no free lunch, and Iraq has again turned into a quagmire (perhaps predictably and inevitably, given its long history of Sunni/Shiite discord), replacing the Russian/Ukraine conflict as the hot spot that could ultimately pose real threats to global security, oil prices, and economic recovery. But a Wall of Worry is important to the bullish case by keeping excessive exuberance under control.

Also keeping price progression orderly is the fact that economic expansion is slower than prior recoveries from recessions, so we have not seen the typical excesses that lead to sudden corrections. And now all signs (finally) point to improving economic growth rates later this year. Furthermore, there is a lot of fuel for stocks in the form of cash on the sidelines and in underperforming bond funds.

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To be sure, the old adage that you should never short a dull market has certainly rung true lately. There has not been a 10% pullback in U.S. stocks in nearly 3 years. And with the VIX now flirting with single digits, it has been two months since the S&P 500 last had a 1% daily move up or down (the longest such period since 1995, by the way).

Moreover, the CBOE Market Volatility Index (VIX), a.k.a. fear gauge, hit a 7-year low on Friday of 10.34. Although some observers are predicting single digits for the VIX, others insist that the extreme oversold conditions are ripe for reversion to the mean sometime this summer, perhaps to test resistance at 15.

In any case, short of a major black swan event, I just don’t see anything on the horizon that could seriously derail the bull train in its upward path. I recommend sticking with the trend of rotation from speculative names into quality companies with attractive valuations, solid earnings growth projections, sound earnings quality, and preferably paying a consistent dividend.

To this end, Sabrient just launched its annual mid-year Forward Looking Value portfolio, which is a cap- and sector-diversified group of 35 GARP (Growth At Reasonable Price) stocks, selected based on a combination of our proven quant model (for identifying high-potential candidates) and subsidiary Gradient Analytics’ forensic accounting expertise (to evaluate earnings quality and avoid those stocks at higher risk of a meltdown due to accrual accounting issues).

h2 SPY chart review:/h2

The SPDR S&P 500 Trust (ARCA:SPY) closed Friday at 195.38. As I said in my previous article two weeks ago, a pullback was inevitable given the extremely overbought technical conditions, and indeed it has pulled back somewhat. Although the current consolidation is allowing the moving averages to catch up with price, the oscillators have been reluctant to cycle back down, particularly MACD, which is still clinging to the roof, so to speak. Instead of testing important support levels (starting with the 20-day simple moving average), price merely formed a bull flag pattern and took another run at the upper line of the long-standing bullish rising channel -- which once again proved impenetrable. To breech this line, I think volume is going to have to increase, which is not likely until we get oscillators like RSI, MACD, and slow Stochastic to cycle back down to oversold territory. But this does not necessarily mean a large pullback in price. A test of the 50-day SMA (around 190) would be a good start, since it coincides with round-number-resistance-turned-support.