Why this Market Will Continue to Ride the Wall of Worry

Amid continued concerns about the economy, slowly the stock market has been edging upward, setting the groundwork for a good year for stocks. Many factors are playing out behind the market’s advance:

In spite of predictions to the contrary, corporate profits have been rising. The market is as quick as ever at punishing companies not making their forecasts. Just look at Adobe Systems Incorporated (NASDAQ/ADBE) this morning; despite the company’s profits being up 69% for the third quarter, the stock is down 20% this morning, because the company is pulling back on its future profit forecasts. This year, the market has clobbered companies not making their earnings forecasts (like the Adobe Systems example), and has only slightly rewarded companies beating earnings estimates.

The primary purpose of the stock market is to price the equities that trade in the market based on the current and future earnings and dividends of the companies issuing the equities, the corporations issuing the stock.

Looking at the S&P 500 this year, the majority of companies have come out better from the recession than analysts had predicted. We had a slew of companies posting better-than-expected earnings in the first and second quarter of this year. Soon, we will see third-quarter earnings also surprise on the upside.

Market sentiment has also been a big positive for the stock market. Retail investors have not participated in the market rally that started on March 9, 2009. Most consumers, stock analysts and economists are still very concerned about the economy. This is a perfect environment for the stock market. When everyone is worrying, the stock market rides that wall of worry.

Finally, there are few alternatives to the stock market right now. There is a bubble in the Treasury market, where money is flocking in for a paltry return of 1.29% on a five-year Treasury. Don’t bring up the phrase “real estate,” because no one wants to hear it. And, as for gold, only a very small percentage of investors have taken a position in the metal. Stocks are a good alternative for money to flow into right now.

I realize I’m one of the few advisors or economists out there who’s bullish on stocks in the immediate term (right now).

Large public corporations are holding record amounts of cash in their bank accounts. They are borrowing ever so lightly. So, companies have the money to withstand further economic weakness and the money to expand if the economy gets better. Given the record-low-interest-rate environment that prevails today, large U.S. corporations are likely in the best position in which they have been in years.

But I’m only immediate term bullish (right now) on the stock market. On Friday, you’ll read why, looking further out, I turn very bearish on the economy and the stock market.

Michael’s Personal Notes:

There was plenty of media coverage yesterday on the Federal Reserve’s statement from Washington. Here’s text from the FOMC statement in case you missed it:

“The committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodations if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.”

So, what did you think of the statement? Same as me — you yawned? I don’t understand what all the media hype was yesterday on the FOMC’s position. The word “inflation” was added into their standard text and that’s where the media focus went.

The Fed has been worried about deflation since the housing bubble burst. This is not “new” news. Of course, the Fed wants inflation. No one wants a repeat of Japan’s lost decade of deflation, especially in the West. With $2.0 trillion in securities on its balance sheet, the Fed is setting the groundwork to buy more Treasuries to hopefully push down interest rates. It will be called “Quantative Easing Part II.”

There are two camps of thought on the Fed’s coming actions: The Keynesians (which unfortunately is the route our government has taken so far) believe that the public sector needs to intervene in the economic system to stimulate growth. Ask someone unemployed in the U.S. about what should be done about the economy and they will tell you that the government needs to do more (Keynesian).

I’m in the camp that believes the government has gone too far in trying to stimulate the economy, that many of their efforts have backfired, leaving us with ridiculous debt, and that, by intervening again in the marketplace, they are actually making things worse. What will the Fed do? Print more money to buy another $1.0 trillion in U.S. Treasuries?

The ramifications for such actions could include severe downward pressure on the value of the U.S. dollar, abiding the spiraling U.S. debt and setting the stage for hyper-inflation. I’m still trying to see where it says in the Constitution that my taxpayer money can be used by the government to buy shares in a car manufacturer.

Where the Market Stands:

The Dow Jones Industrial Average opens this morning up 3.2% for 2010. Add in a dividend of 2.7% and stocks have returned close to 6.0% this year, a much better return than what the flock running to U.S. Treasuries has earned.

Over the past couple of months, I have written how I felt stocks were not overvalued compared to the return on T-bills and other bonds. In fact, several times, I stated that quality equities were attractive alternatives to the meager returns from bonds. I continue with this belief.

Albeit a short sabbatical, the bear market rally that started in March of 2009, in my opinion, remains intact.

What He Said:

“Why Google stock will go higher: Most investors in Google, surprisingly, are retail investors. And that’s why the stock can go higher — because only 20% of the stock is owned by institutions. If the institutions jump in and buy Google, the stock will certainly move higher.” Michael Lombardi in PROFIT CONFIDENTIAL, June 2, 2005. Michael recommended Google stock as a buy on June 2, 2005, when the stock was trading at $288.00. On November 5, 2007, when Google reached $700.00 U.S. per share, Michael advised his readers to sell their Google stock and to put the proceeds into gold-related investments. Coincidently, gold bullion was also trading at about $700.00 per ounce in November, 2007. Michael’s message was to trade each $700.00 share of Google into $700.00 of gold, because he saw gold as a much better investment. Today, gold sells close to $1,300 per ounce.