Sep

15

S&P500 = 1002: What is Driving this Market Comeback?

Posted In: Investing Tips

Financial markets are driven by forward looking data and the anticipation of what is to come. This is true in both directions: down and up. Markets are now suggesting that there is much good news to come, as they drive higher and higher.

We are at the door in two of the major world markets: the S&P 500 and the NASDAQ Composite. The S&P500 finished the day Friday at 986 and is trading right at a key barrier at 1002.63 at the close on Monday, August 03. The NASDAQ Composite last traded at 1975 on Friday and is now at 2008.61 at the close, Monday.

What is leading the markets higher given the terrible levels of unemployment and recent weak economic growth in America? The markets discount the future by at least 6 months, and up to a year in times of economic clarity. What the markets see today is a much better economic landscape in the middle of 2010.

Economic stimulus of all forms is beginning to take hold. It is unfortunate there is such a lag between the time stimulus is authorized and the time it is implemented, but such is the nature of big government. Very important too, is that the banking industry has been secured. This has stopped the unwinding of credit through the firesale-selling of credit securities.

By the middle of 2010, banks and bank-like businesses (GE, GMAC, insurance cos., et al) should begin reducing their reserves against potential loan and derivative losses. The recapture of those reserves go straight to the bottom line and will fire up corporate earnings in the financial sector for several years to come. Improved earnings in the financial sector will result in somewhat easier lending standards (though not for a long time as easy as 2005). Freer lending will result in formation of new capital and expansion of industry and business. This expansion will require new employees which will reduce unemployment. Reduced unemployment will result in higher levels of consumption.

Thus begins the virtuous cycle of economic recovery. Jim Paulsen today (Monday, August 3) on CNBC made a similar case for recovery. He also talked about a potential “gap up” once the psychological barriers of SP500 at 1000 and NPQ Composite at 2000 are cleared convincingly (perhaps with the next week). Such a gap up would begin with a next day open substantially higher than the prvevious day’s close. This happens as investors who were committed to being Bearish (who were drinking the Roubini Koolaid), change camps overnight and become reluctant Bulls. This instant switch of sides can have dramatic effects on a market. Paulsen thinks a 30% pop (from 1000 to 1300 in the SP500) is not out of the question. He did not provide a time frame for this event, but it is probably by year end.

None of this is to say that there will not be pullbacks and corrections along the way. There will be. And one can be expected before year end during this potential “melt up”. There are still a lot of problems in the economy to be resolved. At times, the market will step back and see those problems, and worry once again if those problems might not thwart the recovery. And then the markets will sell off. But such pullbacks will provide new opportunities for investment and will be cut short within 4 to 6 weeks.

Recovery is in the air.

Get cautiously long all the markets and be prepared to stop out short positions if the market gaps up.

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Article Source: S&P500 = 1002: What is Driving this Market Comeback?