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Jeff Saut: Breakout or Fake Out?


This is the question du jour as equity markets rally and the S&P is lifted.

Editor's Note: The following article was written by Raymond James Chief Investment Strategist Jeff Saut. It has been reproduced with permission for the benefit of the Minyanville community.

"It takes a licking and keeps on ticking" is a phrase lionized by pitchman John Cameron Swayze in the Timex watch commercials of an era gone by. Similarly, the same can be said about the current state of the stock market, as despite the Asian Angst, the overbought observations, the vitriolic violation of the 10-DMAs, and all the other negatives mentioned by the "bears," the chant continues: "Cautious yes, bearish no."

Consider this: At the March 2009 "lows," the equity markets were at least 3, and possibly 4, standard deviations below norms. Remember that a 3-standard-deviation event is something that's supposed to occur once every 750 years, while a 4-standard-deviation event happens every 31,750 years.

Accordingly, at the March 2009 "lows," I was aggressively bullish; and, even though over the past 2 weeks I've been wrong-footedly cautious, I've never given up on my 1050 target for the S&P 500 (SPX/1026.13). Indeed, the nearly 6-month rally has left the major market averages only neutrally valued based on historic metrics. Therefore, it's not too much of a stretch to think the "averages" could actually achieve a reading of one, or even 2, standard deviations above norms to achieve the "greed factor" so often mentioned in these missives. That would obviously imply targets above our long-standing 1050 target. And last week, the equity markets defied all of the cautionary comments by rallying another 2.2%. Said rally lifted the S&P 500 above the upside top of the "flag formation" that's developed in the charts over the last 3 weeks, causing one old stock market wag to exclaim, "Is it a breakout, or a fake out?!"

Manifestly, "Cautious yes, bearish NO," because the equity markets are merely fear, hope, and greed only loosely connected to the business cycle. Now, if the typical sequence continues to play, the negative nabobs -- who opined that the world was coming to an end last March -- will continue to espouse that this is just a "short covering" rally in a bear market. To which I constantly remind them that in the beginning of every new bull market, most participants believed that it was/is just another rally in an ongoing bear market.

Such consensus views tend to be wrong (just like they were wrongly bullish at the October 2007 "top") because consensus view is based on a more-or-less extrapolation of past trends and doesn't effectively incorporate change into expectations. Verily, most investors, being human, are "social" creatures, preferring herd-like instincts to stand-alone behavior. As legendary investor T. Rowe Price opined, "Most (investors) fail to appreciate that change really does occur at the margin. If one can learn to think clearly about the margin, change becomes less surprising, timing improves, and better investment results are sure to follow."

Subsequently, last March the equity markets bottomed, amid consensus "cries" of an oncoming economic depression, and built into the explosive rally we've experienced over the past 6 months. Since then the "bears" have steadfastly maintained that this is just a rally in a bear market, despite the recent bull market Dow Theory "buy signal."

Currently, the bears' banter du jour is that the improving economic environment is merely an unsustainable "inventory rebuild." Yet if past is prelude, as inventories rebuild, capital expenditures will follow. Further, those capital expenditures tend to lead to improving employment readings that in turn foster consumption growth. Such a sequence expands corporate profitability and drives more capex. And that, ladies and gentlemen, is the typical economic cycle. However, while I remain bullish in the intermediate term, I continue to question how strong the economic recovery will be.
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No positions in stocks mentioned.
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