If This Indicator Turns, the Stock Market’s in Trouble…

Factors Now Creating a Positive Backdrop for This Stock MarketWith the stock market jittery due to geopolitical events, its underlying strength is highlighted by the relative outperformance of the NASDAQ Composite, the Dow Jones Transportation Average, and the Russell 2000. If these indices are doing relatively better than the S&P 500 and Dow Jones Industrial Average, then there is still an underlying strength to a market that hasn’t experienced a material correction for far too long.

The stock market has done a very good job of recovering from January’s sell-off. Certainty from the Federal Reserve, fourth-quarter earnings results that were modest but mostly met expectations, and strong corporate balance sheets are providing a decent fundamental backdrop. The stock market can have another decent year if it isn’t sidetracked by some sort of lasting shock.

The other indicator that is not directly related to the stock market but certainly is worth taking note of is the spot price of oil. Oil prices have been holding quite solidly above the $100.00-per-barrel level.

Stronger oil prices are a reflection of their own specific fundamentals, but they’re also a barometer or gauge on the part of speculators regarding future economic activity. The spot price has brought back a lot of oil stocks that recently sold off and valuations are creeping up close to previous levels (which was very expensive for Bakken oil stocks).

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I maintain a positive outlook for the stock market given current fundamentals and recognize, of course, that geopolitical events can turn investor sentiment on a dime. If the stock market were to experience a substantial price correction right now, I would view it as a buying opportunity.

Earnings estimates for many blue chips didn’t really change after fourth-quarter reporting, and corporations themselves offered up no real modification to their existing outlooks.

Dividend income is still a very important attribute in a portfolio. (See “A ‘Boring’ Investment Strategy That Always Pays.”) Stocks are still very close to their all-time highs, and there is a lot of froth in valuations.

A material price correction would be a healthy development for this stock market, but with the central bank still highly accommodative and corporate balance sheets so strong, more capital gains later in the year is an easy possibility.

There isn’t a lot of new action to take with an existing portfolio of dividend-paying blue chips. Some speculative fervor has already come out of this market, and you can see this in the trading action of initial public offering stocks (IPOs) and 3D-printer stocks, as an example.

But as a near-term indicator, the relative outperformance of the NASDAQ Composite to the other main indices is key. Since last July, the NASDAQ started to outperform and then the gap increased materially.

It’s hard to imagine the stock market accelerating in the current environment.

But on down days, if the NASDAQ Composite starts to retrench more than the S&P 500 and the Dow Jones industrials, then this would be a strong signal that the market is up for some material downside.