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Why the Correction Vanished and the Bull Is Charging

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The odds seemed to favor a classic stock market correction this autumn in the face of two headwinds: the trade war and the mid-term elections.

Big name Wall Street economists, strategists, and money managers like Ray Dalio of Bridgewater, the world's largest hedge fund, have been warning investors to run for the hills for months.

But you would never know it looking at the strength of the market lately as all the indexes flirt with new highs and consumer, industrial and cyclical sectors lead the charge.

What did the bears miss? And are they just early, or destined to be disappointed the rest of the year?

First, they underestimated two giant stock market tailwinds that are easily overpowering those minor headwinds: strong economic momentum and record earnings growth.

Next, in this report we'll take a closer look at this macro battle and try to determine if a seasonal correction of 5% or more is still probable, or more likely off the table.


The 2 Minor Headwinds

1) Trade Battles: While fresh deals are being struck with Europe and NAFTA, the two heavyweights of the global economy, the US and China, have dug in their heels and appear no closer to any compromises than they were a couple of months ago.

There was always hope that the escalation of tariffs by the US was just part of a bold and clever negotiating strategy -- and that eventually this strategy would lead to several fruitful deals instead of a messy, protracted trade war that could hurt many US companies, big and small, across every sector.

But even as that hope appears dashed, equity investors' demand for stock market exposure has climbed unabated. In fact, we got the worst-case scenario this week from someone who should know, the founder and retiring Chairman of Alibaba Jack Ma, who said Tuesday that trade conflicts between the US and China could last 20 years.

If the stock market can keep pushing for new highs above S&P 2900 with this worst-case view, imagine what will happen if the two behemoths make some deals! This is also the view of Goldman Sachs chief economist Jan Hatzius who has been saying that the trade battle will have "little impact" on the US growth trajectory.

2) September Remembers: This month is not only the weakest performer of any historically, it is also especially red every four years, on average, during the mid-terms of the presidential election cycle. And the potential for flipping either body of Congress to the other party would make this particular November especially contentious, creating lots of uncertainty.

But I did some more digging in the historical patterns of the last 100 years and found that a strong bull market can easily wipe out this seasonal tendency. When the market is up 5% or more for the year, especially after the tricky May through August period, September actually comes out green.

This is clearly a case of momentum and investor risk appetite begetting more of both. And a strong first nine months of the year doesn't lessen the performance of a classic Q4 rally -- it enhances it!

So don't let the "correction by rotation" fool you. This market is technically strong and the sentiment is not wildly bullish like it was in January, so there is far less "froth" to wring out than a reasonable observer might calculate. After you read about my two tailwinds, I'll tell you how to play "the correction that got canceled."


The 2 Giant Tailwinds

1) Economic Momentum: The big tax cut has given corporations, workers and investors a lot of visibility about their economic prospects. This clarity and extra cash have in turn unleashed a fair amount of animal spirits and record-busting consumer and business confidence.

We see it in actual growth metrics like GDP and employment, and also in survey data like the manufacturing ISM and the NFIB Small Business Optimism Index which marked its second highest level in the survey's 45-year history at 107.9, rising to within 0.1 point of the July 1983 record-high of 108.

2) Earnings Growth: When you have pro-growth tax policy and economic momentum like this, it translates into higher corporate profits. With Q3 earnings expected to be up 18%, 2018 total earnings for the S&P 500 index are on track for a 20% gain on +6.5% higher revenues.

And full-year 2019 earnings are expected to be up +9.7% on +4.9% higher revenues. When large investors plug these numbers and the macro economic data into their models, it spits out one conclusion: keep buying stocks! To put a single number on it, my call is for S&P 3,300 by year-end 2019.

Continued . . .


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Strong Like Bull

I think you can see that the tailwinds are bigger and more powerful than the headwinds. That's also because of other adjacent tailwinds like de-regulation, corporate repatriation of overseas cash war chests, and favorable interest rates, which are only rising in a slow, predictable path.

There's also talk in Congress about Tax Reform 2.0 which will give further visibility and confidence to business and consumers as some relief will be made permanent and other incentives for US expansion and innovation will be established.


Wait For It...

My conclusion is the two minor headwinds could still foster some unpredictable fear in the near-term, but that any dips we get in the next few weeks will be bought aggressively. So your task as an active investor/trader is to start making your shopping list now of favorite ideas.

The Zacks Rank will get you started as it maps out the entire market with the single most important fundamental metric: earnings momentum. Then, go to the charts and see which of your top ideas are in bullish trends and buy zones, or getting close to good entries.

Finally, execute your plan fearlessly when the pullbacks come by remembering the power of the bullish tailwinds that will take the stock market above S&P 3,000 in the next three months, if not sooner.


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Good Investing,

Kevin

Kevin Cook, Senior Stock Strategist at Zacks, is a leading expert in technical analysis and what makes markets move. He provides commentary and recommendations for the Zacks TAZR portfolio.




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