No Growth? No Problem

No one's denying there are economic issues, but it doesn't pay to fight the tape.

   

Along with another up day on Monday, the S&P 500 Volatility Index (VIX) gapped lower at the open, then proceeded to plunge the rest of the session by 8.2%, finishing at its lowest level since early 2007. You don’t need any better indicator of investors’ complacency at this point in the cycle. It’s as if a mist of Prozac has suddenly descended on Wall Street, blissing out the crowd and encouraging them to march peacefully higher together, hand in hand.

Somehow, one senses that something will come along to shatter the calm — but that seems like a crass thing to say at a time like this. It’s almost like a mellow peace after wartime. It’s kind of nice to be able to wake up and not have the expectation that the Dow might be down 100 points because of something the deputy minister of melancholia might have said overnight at a eurozone summit.

After seeing so many of these days in reverse over the past five years — you know, where the market started higher and then accelerated lower into the close — it is nice to simply relax and enjoy the uptrend, isn’t it? Worrying about what might ruin it just seems like a wasted emotion at this point.

The Dow reached another record closing high and the S&P 500 is now under 10 points from its record high; both rose for the seventh consecutive trading session. Trading was fairly quiet on Monday and marked by low volumes. Besides slightly disappointing data from China for February, there was little change for major macro themes, and company-specific news was also limited. Financial industry stocks led the market higher, while telecom was the only sector in the red.

What’s interesting is that equity prices have surged without the help of much new money, as inflows into stock funds have not been very impressive so far. You have probably seen commentary that the public rushing into the market has propelled the indexes higher. This makes no sense, as there have been tens of billions of dollars in outflows from stock funds over the past four years. And even recently the inflows into equity funds have been matched by inflows into bond funds. In other words, the market has doubled without much public participation.

While it might seem puzzling to see stocks up sharply without the economy doing much, it actually makes sense. Domestic economic trends are not super-strong, but they are good enough to boost corporate earnings growth, which in turn supports share prices. Job growth is likely to be sustained and earnings are also expected to pick up as companies spend more. Citigroup (NYSE:C) notes that while investors worry about peak-like S&P 500 margins, it is crucial to recall that only two of the 10 industrial sectors have enjoyed margins above their prior cyclical peak, leaving plenty of room for improvement.

Bears’ greatest fear at this point is that central banks might reverse course and tighten policy. This is very unlikely, as I have mentioned many times in the past. Fed chair Ben Bernanke has insisted repeatedly that he will maintain an accommodative monetary stance in place well past the time that a sustained recovery emerges.

NDX311 No Growth? No Problem

Moreover, Citi analysts noted last week that over the past 20 years, the periods before rate hikes were very positive for energy, industrials, materials and techs — and missing those moves because you’re afraid of a reversal has been harmful to the success of portfolio management. Plus it’s not like tech stocks, as an example, are wildly overpriced here near market highs. In fact, they are still well off their levels of 13 years ago, as shown in the chart of the Nasdaq 100 above.

Bears are most concerned that stocks are up 100% in the past four years without the benefit of much real economic growth, and contend it has been one long farce staged by the Federal Reserve and its fellow central banks that will end badly. They point most recently to a decline in year-over-year earnings growth and weak guidance from companies for the second quarter, and argue that stocks should not have enjoyed such a great quarter.

Everything they say about the lack of earnings growth is true — but misses the point. The Fed anticipated this corporate weakness, and has blunted its effect by flooding the financial system with cheap money via its asset purchasing program known as QE3.

Economists and skeptics may scoff; it’s their right. And I share their concerns. But after studying the last 200 years of U.S. and European market history, I have come to realize that there can be long periods in which there are big gulfs between market returns and corporate earnings growth. At the moment, I am solely bullish in my Trader’s Advantage service to capitalize on a continued move up in stocks. We don’t necessarily need economic growth to make a profit.

InvestorPlace advisor Jon Markman operates the investment firm Markman Capital Insight. He also writes a daily swing trading newsletter, Trader’s Advantage which aims to capture profits of 15% to 40% and often as much at 100% to 200% in less than 90 days. 

Professional traders and hedge funds make huge profits off volatility.  Now, Jon’s service CounterPoint Options levels the playing field with the first service geared towards helping individual traders make steady, consistent profits with the VIX.  Get more information on Trader’s Advantage and CounterPoint Options today.


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