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The Bull Market in Stocks Isn't Over Yet

Although he’s getting more nervous, a leading market forecaster says the pessimists are wrong—for now.

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Greece and Puerto Rico teeter on the edge of default, roiling markets worldwide. U.S. corporate earnings are anemic, and profit margins are falling. And the Federal Reserve appears to be laying the groundwork to hike interest rates in September, which would be the first boost since 2006.

See Also: This Market Indicator Suggests a Continued Bull Market

But the long, painfully slow U.S. economic recovery from the Great Recession continues to gather steam. The Conference Board’s index of leading economic indicators keeps posting new recovery highs, and joblessness continues to decline as businesses ramp up hiring and production.

These indicators invariably reverse course six months or longer before the onset of a recession—and bear markets almost never occur without an accompanying recession. That means stocks should continue to rise—at least through the end of the year.

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But don’t listen to me. Instead, do what I do when it comes to the devilishly tricky business of calling market turns. Listen to Jim Stack, editor of InvesTech Research newsletter. Over the past 10 years through June 30, the newsletter’s model portfolio has returned an annualized 8.9%, according to the authoritative Hulbert Financial Digest. That’s an average of one percentage point per year more than Standard & Poor’s 500-stock index.

Stack accurately predicted the onset of both the 2007-09 bear market and the bull market that began on March 9, 2009, and continues till this very day. Since the start of the bull market, Stack has remained a steadfast, though increasingly nervous, bull as the U.S. stock market has continued its bumpy and danger-filled ascent, now in its seventh year.

Explains Stack: “Bear markets almost always accompany or precede recessions. The only exceptions in the past 50 years were in 1966, which almost qualified economically as a recession, and 1987, which could have turned into a recession if not for instantaneous Fed easing.”

Stack, who operates in bucolic Whitefish, Mont., thousands of miles from Wall Street, foresees a strengthening economy for at least the latter half of 2015. He bases his judgment on a steady increase in the index of leading economic indicators, which reflects an improving employment picture and soaring consumer confidence, among other things.

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Not that Stack doesn’t see trouble on the horizon. Like all of the few decent market timers I know, he tends to worry a lot. And lately his pile of worries has been accumulating at a rapid pace.

Indeed, he recently raised the cash stake in his newsletter’s model portfolio to 24%, leaving the remaining 76% in exchange-traded funds that invest in stocks. That’s a lower allocation to stocks than he’s had in six years, but still a relatively bullish posture.

Stack mixes economic and technical analysis—that is, the behavior of the market itself—in making his market forecasts. And the technical half of his crystal ball is turning increasingly cloudy.

In a healthy bull market, most stocks rise along with the major large-company market indexes, such as the S&P 500. So do indexes of small companies and the Dow Jones transportation and utilities averages. Currently, the major large-company indexes are alone in hitting new highs, and, overall, more stocks are declining than advancing. “The deteriorating technical outlook is at the top of our list of concerns,” Stack says.

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Expectations that the Fed will soon begin to tighten monetary policy by raising short-term interest rates has Stack particularly edgy. Five of the past eight Fed tightening cycles have occurred at or near market tops, Stack says.

Finally, this bull market is now the third-longest in the past 85 years. That has led investors to become overconfident and to take on record amounts of margin debt—borrowing against the securities in their brokerage accounts. That kind of behavior rarely turns out well.

Bottom line: Stack remains bullish, but he thinks we’re in the latter innings of the bull market. His model portfolio has the lion’s share of its assets, therefore, in ETFs that invest in sectors that tend to do well in the late stages of bull markets.

Want to tilt your portfolio like Stack’s? He currently has 16% of his assets in Health Care Select Sector SPDR (symbol XLV), 15% in Technology Select Sector SPDR (XLK) and 13% in Consumer Staples Select Sector SPDR (XLP).

Steve Goldberg is an investment adviser in the Washington, D.C., area.