May tends to bring the bears out of hibernation as we enter the "worst six months" of the year. But thankfully, there are also statistics to rely on other than the latest "Sell in May" article.
The fact that 60% of Mays have closed higher in the past 40 years is worth noting. And in years when the preceding three months were higher, 56% of Mays have been positive with a median return of 2%.
A correction is probably around the corner this summer -- and I will tell you how to play that event when the time is right. But, right now, let me explain the "3 Drivers for New Highs."
1) The Economy and Earnings
One of the most pleasantly surprising facts to surface about the economy recently is that it was busy creating jobs during one of the harshest winters in a while. The first four months of the year created an average of about 215,000 new jobs, which tops the average for all of last year at just under 195k.
This is one of the strongest barometers of economic growth. And though that growth has been struggling to average 2% GDP, there are no signs of a recession on the horizon. Recent strong surveys in manufacturing and services - as well good data from housing, retail sales and consumer spending, incomes and confidence - also bolster the case that the economy is building momentum.
When you have that kind of underlying fundamental momentum, then it's easy to see how earnings can continue to grow. And when earnings are growing - and setting new records every quarter - then you can see why institutional investors continue to put money to work in stocks.
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As Q1 earnings season firms up, it looks like we could see another quarterly record close to $27 EPS for the S&P 500. And from there, the estimates track higher to an expected $31+ for Q4. Add them up and you get $117 for the full year.
Now divide that number into S&P 1900 and you get 16.25. That's the P/E multiple for the broad market index. Not terribly cheap, nor expensive.
Here's the key way to view these numbers: in an expanding economy where corporate balance sheets are strong and interest rates are seen to remain low for a considerable time, the stock market has not yet seen its peak because that multiple will probably expand to 17-18X.
If the market continues to discount the positive economic and earnings trends, a conservative 2015 EPS estimate of $122 multiplied by 17 puts the S&P index at 2,074.
Yes, the bull market is getting up there in terms of age. And the market always runs ahead of the economy by at least 6 months. But the expansion has been slow and steady, almost as if it has found a path to stay clear of the old boom-bust volatility. And this means that the direction for earnings is still upward, keeping that P/E multiple respectable and affordable.
2) The Technical Picture
For growth investors, a not-so-funny thing happened on the way to the S&P's new highs over 1900 this year: a take-no-prisoners correction in growth stocks, from Social Media and Cloud industries to Biotech and Clean Energy industries.
Many of the highest-flying stocks that led on the way up last year have been cut in half. And the Russell 2000 Small Cap index just closed below its 200-day moving average for the first time since November 2012.
My thesis is that one correction has already happened this year and that another broader one will come later. It was a very healthy correction to wring out the excesses in high-multiple stocks. And now many of them will get lifted as the much stronger S&P and NYSE indexes rally to new highs into June.
How strong are those indexes? As noted earlier, the S&P 500 closed successively higher in the months of February, March and April. If this were not the case, I would be arguing for a big correction right now as big caps could be expected to follow the growth indexes, like the Nasdaq, lower.
This strength has been partly defensive in nature as institutional investors reallocated capital from growth areas to blue-chip safety and yield. But as long as the S&P keeps finding buyers in the 1800-1850 area, it argues for broad market accumulation that usually leads to higher prices.
But isn't the downside right now greater than the potential upside? Yes, it is, especially if the market unfolds into a correction. But the way I play all indexes and sectors, including the "growth" indexes with the high-flying momentum stocks, is by using ETFs. That way I avoid single stock risk and potential blow-ups. Plus, these ETFs are so liquid, you can get in and out any time you want at your pre-determined buy and sell levels.
3) The Behavioral Dynamic
This part of my analysis is the hardest to quantify, but it often provides some of the best market timing clues. It's all about gauging what institutional investors have to do in their regular course of business - namely, buy stocks - and what they will do in certain situations.
You see they have money flowing into their funds almost every month. It comes from other more conservative institutions that just want their money managed, from individuals, and from sovereign wealth funds around the world. In fact, Citi just won the business of the largest SWF in the world, the $866 billion Government Pension Fund of Norway.
Where does this money go? Into stocks and bonds. It's almost automatic for some institutions. And with bonds offering even less upside than stocks, more and more money finds its way into the market.
Now that's just the steady backdrop for institutional investors during an expansion. What we are interested in are the swings of sentiment that create buying and selling opportunities within that backdrop.
Many hedge funds are masters at moving the market back and forth on troubling news. And many institutions have learned to love this behavior because it's when they get to add to their favorite stocks.
We want to buy when there is fear and a general mood of "I'm done with this market. I just don't see how it can go higher from here."
And now that the corrections and rotations have happened, I think that's the market we have on our hands right now. And that's why I am buying in May.
And When I Pull the Trigger . . .
You can be there with me, receiving email alerts from our private service where I focus on the three drivers mentioned above: Zacks Market Timer.
In 2013, this portfolio more than quadrupled the average hedge fund with an overall gain of +31.1%. Yet now the profit potential could be even more explosive. Unlike last year's steady bullish climb, 2014 looks to be a full year of sharp ups and downs, and that is what Market Timer is designed to thrive on.
We aim to profit from quick swings in industries, sectors and the market as a whole. While cutting losses short, we maximize gains by 2X with a simple Zacks metric and then 3X again with a twist on a common investment move. If that sounds interesting, I encourage you to check it out. You are welcome to follow our moves and commentary for 30 days, along with those of our other 12 Zacks portfolios, at a total cost of $1.
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Kevin, a Senior Stock Strategist at Zacks, is a recognized authority in global markets and renowned for predicting market swings. A former market-maker in the $4-trillion-dollar-a-day world of interbank trade, he developed the ability to track the movement of money, and trained his reflexes to take advantage of it. Today he directs the Zacks Market Timer, providing commentary and recommendations.