A Favorable Outlook, on Balance

07/20/2010 11:00 am EST

Focus: MARKETS

David Fried

Editor, The Buyback Letter

David Fried, editor of The Buyback Letter, says that his seven key market indicators are painting a positive picture about the market.

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: inflation. 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 average rose just 1.3% per year. Currently, inflation is running below the 5% mark. The inflation trend remains very positive.

Big trend #2: long-term bond yield. Peter Lynch, the famed fund manager of The Magellan Fund during its glory days, used 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 yield on the S&P 500 is 2.1% while the yield on 30-year government bonds is about 4.37%, [so the] dividend yield indicator [is] positive.

Big Trend #3: Federal Reserve. The Fed cut rates significantly over the past year and a half and has stated that it will keep rates low for the time being, [so the] Fed indicator [is] positive.

Big Trend # 4: The yield curve. Currently the short-term yield is in order compared to the ten-year note and the 30-year [bond], while the relationship of the ten-year to the 30-year yield is also in order. The yield curve spread is in order. [The] yield curve indicator [is] positive.

Big Trend # 5: Valuation. The S&P 500 trades at about 17x trailing earnings. Given current low interest rates, it’s hard to make the case that stocks are as drastically overvalued or undervalued at this time. [So, 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. The average total reading for the month ending June 30, 2010 was 164. 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] neutral.

Big Trend #7: Money supply. The money supply is a macroeconomic concept that covers the quantity of money available within the economy to buy goods, services, and securities. The broadest measure of money supply available is called M2, [whose increase recently] has waned. [The] M2 Indicator is neutral.

Four of our seven indicators are positive, and three are neutral. Our indicators are telling us the investment climate is mildly positive at this time.

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