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Over the last few weeks we have been
seeing anecdotal evidence that the
US, and global, economy picking
up; this has been rather small and it probably does not explain by itself
the resilience in the major indexes and the uptrend we have been seeing so
far this quarter. Our conclusion is that there is a change in sentiment
going on with increased risk appetite fueled by anticipation that there will
be global GDP growth in Q3, or Q4 at the latest, coupled with optimism about
corporate profits and rounded out by huge cash positions waiting on the
sidelines ready to be invested. We also believe that optimistic statements
will be issued by the G20 and the Federal Reserve later this week that will
only add to this improved market sentiment.
With the 3rd quarter winding
down, the S&P 500 is up almost 20% (year to date) with the bulk of that
increase, about 15% occurring in the third quarter so far (+7.5% in July,
+3.6% in August, +4.4% through September 21). While the huge rally off the
March lows is often talked about, it is important to note that in the first
two months of the year the S&P was down about 19% (on the heels of a 22%
decline in Q4 2008). So basically, at the end of Q2, more than three months
into the rally, we were about break even on the S&P 500 for the year.
The reason for the above illustration
is to show the gradual change in sentiment that the market has been
undergoing. While Q1 was characterized by a continuation of the sell off we
witnessed in Q4 2008, Q2 was a technical rebound fueled by massive
government stimulus measures coupled with profit taking by short sellers
covering their winning short bets. Q3 has been a wait-and-see quarter with
most market participants, this writer included, taking profits in July, and
sitting on the sidelines waiting for tangible confirmations for a market
turnaround beyond just a technical rebound. While it is hard to quantify
“market sentiment” one measure is to look at price action as investors
putting their cash to work is the best evidence of strong market sentiment.
One can not ignore the S&P’s resilience in not breaching the 940 support
level in July and its strength by breaking the 1040 barrier earlier in
September. Other evidence is manifested in increased M&A activity and a
surge in initial public offerings. Just like Q1 2009 was full of
pessimism in spite of massive government measures, we believe Q4 2009 will
be a period of substantial optimism even though tangible positives are still
few and far between.
Save for a profit-taking period
coinciding with the tax-loss selling season occurring around late
October-early November, we anticipate that the current stock market rally to
continue unabated as retail investors return to the market, fund managers
play catch up and invest excess cash that has been waiting on the sidelines,
and short sellers cover their losing short bets. This is a recipe for a high
single digit to low teen percentage advance in the major indexes for the
remaining period of 2009 added to year-to-date gains. A reassessment of
market conditions at the end of 2009 is essential however.
While we have highlighted positive
sentiments above, there are attractive valuations in all the sectors we
like. Our most favored sectors right now are those that are most sensitive
to the economy and capital markets – chiefly Technology and Financials.
Primarily, we like internet advertising companies and those benefiting from
an upswing in advertising spending, and companies that benefit from a rising
stock market, mainly online brokers benefiting from increased retail
activity and investment banks benefiting from the increased advisory and
underwriting activities. Both of those sectors along with the
market as a whole are coming up against favorable quarterly earning
comparisons with the year-ago period over the next 3 quarters starting with
Q4 2009.
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