5 Reasons Stocks May Keep Charging Ahead

Value Added

5 Reasons Stocks May Keep Charging Ahead

The two-year-old bull market has been unusually strong. And it's nowhere near out of gas, says InvesTech's Jim Stack.

Civil war in Libya, the threat of turmoil elsewhere in the Middle East and soaring oil prices making you nervous about the stock market? Given how the market has been behaving recently -- selling off big-time on days when oil jumps -- a bit of anxiety isn't totally unexpected. But Jim Stack, one of the market's top prognosticators, says not to worry: The current bull market, which celebrates its second birthday on March 9, 2011, still has legs.

Most forecasters do a lousy job of calling market turns. They often stay either bullish or bearish for years and years, regardless of what the stock market and the economy do. Even the best ones tend to lose their magic after making good calls for a few years.

In recent years, Stack, president of InvesTech Research and editor of the InvesTech Research Market Analyst newsletter (www.investech.com), has put most of his competition to shame. He called the onset of both the bear market that started October 10, 2007, and the bull market that began March 10, 2009. He has remained firmly bullish since the stock market hit bottom and currently recommends that his subscribers put 93% of their investment assets in stocks.

Even though the market has doubled in just two years, Stack remains upbeat. Why? Let's count the ways.


1. Oil prices haven't climbed enough to be worrisome. The unrest in the Arab world has spooked investors and pushed the price of oil beyond $100 a barrel. Although higher oil prices are a headwind for the economy, Stack thinks they would have to double from current levels to derail the recovery. "Geopolitical events are very unnerving, but they seldom have a long-term effect on the U.S. economy or the stock market," he says.

2. The budget deficit won't hurt the stock market. Stack is concerned about the federal debt: "We’re headed the wrong way down a one-way street, and at some point we'll end up in a head-on collision if we don’t turn around." But, he says, deficits were also sky-high in the mid-1980s, and the economy and the markets did just fine. "Not a single recession in history has been caused by a soaring deficit," he says.

3. The economic recovery is robust. Stack pays close attention to the Institute for Supply Management's survey of purchasing managers in both the service and manufacturing parts of the economy. It asks businesses about their purchasing plans and whether they're hiring more employees. The service sector survey is currently at a five-year high, and the manufacturing sector is close to a 25-year high.

That's not all. The Conference Board's Leading Economic Index is also rising. "Never in the past 50-plus years has the economy dipped into recession within 12 months after such a strong series of readings from the LEI," says Stack.


The Conference Board's Consumer Confidence Index, meanwhile, is at a three-year high. Consumers are more optimistic, making them more likely to spend money.

With housing prices and employment still depressed, Stack doesn't expect a "roaring recovery." Prior to the 1980s, periods of economic growth in the U.S. typically lasted just four years, on average. Looking ahead, Stack expects recessions -- and bear markets -- to occur more frequently, but to be less severe. (See Kiplinger's Economic Outlook.)

4. Technical factors show the market to be healthy. Stack spends much of his time analyzing the market's past behavior for clues to how it will do next. One strongly bullish signal: All three major Dow Jones averages -- industrials, transportation and utilities -- have been hitting new highs. The same goes for the Nasdaq Composite and the broad-based Wilshire 5000 index.

Stack also places a lot of weight on the ratio of advancing stocks to declining stocks. The higher it is, the better. It's a source of concern when investors push up the share prices of a relative handful of companies. Currently, stocks of all shapes and sizes are rising. The market, in other words, has good breadth, a bullish state of affairs.


Stack also studies what he calls "downside leadership," essentially the number of stocks hitting new 52-week lows. The fewer of those, the better. Psychologically, it’s difficult for most investors to sell losers. It's much easier to sell stocks that have gone up. Investors usually don't sell their losers until they've already sold their winners, and panic is setting in. When a lot of stocks are hitting new lows, it's a signal that the market is on precarious footing.

5. Investors remain wary. Although some surveys show an excess of investor optimism, Stack sees no sign of the euphoria that usually signals market tops. "After a decade of getting burned, investors remain lukewarm toward the stock market," he says. For instance, at the World MoneyShow in Orlando in February, Stack found many investors still looking for quick ways to make up their losses -- often through rapid-trading gimmicks.

What should investors do now? Stack thinks we could be in the second half of the bull market. That means he's trimming consumer cyclicals, such as retailing stocks, and avoiding financials. He advises increasing holdings in energy, industrial materials, health and technology.

What are the warning signs of the next bear market? Most important would be a reversal in the trends that make Stack bullish today.


But he also advises keeping an eye on the dollar. A decline of 5% from its current trade-weighted level would be a warning flag; a 10% decline would mean "it’s possibly time to batten down the hatches."

Similarly, he watches the "bond vigilantes," big players in the fixed-income arena who could push down bond prices (and push up bond yields) if they get too nervous about inflation or budget deficits. If the yield on the ten-year bond goes over 4.5% or the yield on the 30-year bond rises above 5%, that would be a warning signal (as of March 7, ten- and 30-year Treasuries yielded 3.5% and 4.6%, respectively).

If the economy does sink into recession anytime soon, Stack worries that the U.S. could be in for a prolonged slowdown similar to that of Japan’s "lost decade" of the 1990s. But he sees little chance of that. For now, two years into a soaring bull market, all systems are go.

Steven T. Goldberg (bio) is an investment adviser in the Washington, D.C. area.