The Market Looks Good—for the Most Part

01/27/2010 11:06 am EST

Focus: MARKETS

David Fried

Editor, The Buyback Letter

David Fried, editor of The Buyback Letter, says that except for investor sentiments, his favorite market indicators are still positive.

Underneath the market noise are solid realities that ultimately rule the day no matter what investors’ near-term hopes or fears may be.

Big trend #1: The inflation trend. Since 1920, the Standard & Poor’s 500 index has gone up an average of 15.5% when inflation was in the 2%-5% range. When inflation topped 5%, the S&P rose just 1.3% per year. The inflation trend remains very positive with the current decline in energy and home prices.

Big trend #2: The long-term bond yield vs. S&P yield. Peter Lynch uses the following rule of thumb: When yields on long-term government bonds exceed the yield on the S&P 500 by 6% or more, sell stocks and buy bonds. The current difference between the two yields is 2.83%, [so the] dividend yield indicator is positive.

Big trend #3: The Federal Reserve has cut rates from 5.25% to the current rate of 0.25% and has stated that it will keep rates low for the time being, [making the] Fed indicator positive.

Big trend #4: The yield curve is in order. The 30-year bond currently yields 3.8% more than the two-year paper, [while] the spread between two-year paper and the ten-year bond is 2.89%, [so the] yield curve indicator [is] positive.

Big trend # 5: Valuation. It is hard to make the case that stocks are as drastically overvalued or undervalued at this time as earnings estimates for the S&P for 2010 average about $50.00-$70.00+. [The] valuation indicator [is] neutral.

Big trend #6: Investor sentiment. We add the total bullish percentage readings of Investors Intelligence, Consensus Index, AAII Index, and Market Vane and average this figure for the month. We consider an average reading of more than 200 to be negative while readings of less than 150 are positive.

The average total reading for the month ending December 30, 2009 was 212. Readings over 240 have marked market highs over the past few years, while readings of about 130 or below have marked market bottoms. [So, the] sentiment indicator [is] negative.

Big trend #7: The broadest measure of money supply available is called M2, and counts forms of money held for immediate transactions [and] money held as a store of value. Currently, M2 is up about 3.5% from the same time last year. However, most of that expansion happened prior to March 2009. Since then the increase in the money supply has waned, [so the] M2 indicator [is] neutral.

Four of our seven indicators are positive (inflation, dividend yield, yield curve, and the Fed), and two are neutral (valuation, money supply). One of our indicators is negative (sentiment). Our indicators are telling us the investment climate is positive at this time.

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