Full Speed Ahead for Stocks

11/01/2007 12:00 am EST


David Fried

Editor, The Buyback Letter

David Fried, editor of the Buyback Letter, says the seven macro trends he looks at paint a positive picture for stocks in the months ahead.

A lot of investors watched with horror during the summer as their equity accounts took a plunge. But by the end of the quarter, the Standard & Poor’s 500 index rose 1.6%, easing some fears.

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: Since 1920, the S&P 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 well below the 5% mark. The inflation trend remains very positive.

Big Trend #2: 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 2.98%. [So, the] dividend yield indicator is positive.

Big Trend #3: After interest rates remained unchanged for eight consecutive meetings, the Fed cut rates by 0.5% in September [and cut them again by 0.25% Wednesday—Editor]. So, the Fed indicator is positive.

Big Trend # 4: The short-term yield is in order compared to the ten-year note and the 30-year note, so the yield curve indicator is positive.

Big Trend # 5: The S&P 500 trades at about 18.1x earnings, the lower end of the P/E range that we have had since the late 1990s. Given the current low interest-rate environment, the valuation indicator is neutral.

Big Trend #6: 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 September 30, 2007 was 207.68, [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, money held as a store of value (various savings accounts, certificates of deposit, and overnight bank repurchase agreements). Currently, M2 is up about 7.2% from the same time last year. An expanding money supply is bullish for equities, and this is a major expansion. [So, the] M2 indicator is positive.

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

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