We are about to enter the most bearish time of the year. Historically, September and October bring downside and even earth-shaking crashes to the equity markets.
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2018 has seen every market pullback turn into new all-time highs in the U.S. stock market indexes. The "buy the dip" crowd is nearing ecstasy with the success of the strategy. It seems that everyone but the bears love this market.
However, the years without a full-fledged bear market, chaos in Washington, and global uncertainty have many market researchers preaching that a big crash is about to happen.
The truth is, when you look behind the hype, things really are solidly bullish entering the bearish season. I do not expect a dramatic sell-off in the stock market this year. This is not idle speculation or talking my book as there are very solid reasons for my statement. In fact, there are seven reasons to be bullish during this bearish time of the year.
1) Yield Curve Inversion
I can hear you asking, "Wait a minute, isn't yield curve inversion a very bearish signal?" It is over the longer term, but in the short term, history shows an inverted/flattening yield curve to be very bullish!
Once the yield curve inverts, it takes around 16 months, on average, for an economic slowdown to start. In fact, studies have shown that stocks advance an average of 15% between the time the yield curve inverts and the start of a recession.
Examples include the December 1988 inversion leading to a recession in July 1990 with the S&P advancing nearly 38% during this time. An inversion in December 2005 driving to a slowdown in December 2007 saw 22% plus returns in the S&P 500.
The only example I could find where this was not the case was during the dot-com crash when the curve inverted in February 2000, and the recession started in March 2001 when the S&P 500 went negative around 15% during the period.
The bottom line is an inverted yield curve likely means more upside in the short term!
2) Strong Earnings
Earnings have been robust so far this year. The projections are 19% earnings improvement in 2018 and another 10% gain in 2019. Positive, growing earnings is a massive catalyst for stock prices, and all signals are that the growth will continue.
3) Stock Repurchases
Stock repurchases are hitting an all-time high. $650 billion is pledged by U.S. public companies this year. Calculations show that the buybacks should add a nearly 3% yield to stocks this year.
In turn, the buyback yield adds fuel to the bullish fire by attracting more capital into the markets in search of yields -- basically a self-fulfilling prophecy.
Markets never crash when the majority is expecting it to happen. The latest stats that I have seen show that over 60% of the public is expecting a sharp selloff to occur this year. It seems that it is near impossible for a market crash to happen with such a strong bearish sentiment. Remember, to survive, the market needs to fool the majority of the investors at any given time. In general, when the majority hold bearish sentiments, the likely direction is higher.
5) Momentum: Slow & Steady
Momentum often begets momentum in the stock market. In other words, as prices climb, the increasing prices attract more buying, forcing the market higher.
Taking a look at the weekly chart of the Dow Jones Industrial Average, the price is in a slow and steady, momentum-fueled bullish run since June 2016. Supported by the 50-week simple moving average, the Dow has been slowly and steadily moving higher with the weeks of selling being sharp yet short lived.
The slow and steady upside punctuated by sharp yet short sell-offs bodes well for additional bullish moves.
6) Rising Interest Rates
Another little-known market fact: Rising interest rates are proof that the economy is thriving, therefore the stock market is pushed higher. Not only do rising interest rates directly help the financial sector (20% of the U.S. economy), but they also attract foreign capital into the U.S. markets.
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Make no mistake, a sharp and unexpected rise in interest rates will have bearish effects and could even derail the bullish run.
However, the Federal Reserve appears to have learned to never shock the market. The central bank is proceeding in a bullish manner with the rate increase plan.
7) The Pullback Already Happened
End of January to April 2018 was a tough period for stocks. It has been a slow and steady advance higher since the Jan. 26 highs. While not an officially defined bear market, the drop shook out the weak hands paving the way for new highs coming soon!
Risks To Consider: The above seven reasons to stay bullish are assuming a steady to improving state in the global economy. They do not consider a wide variety of unknown potential shocks to the economy. We can only attempt to project the future based on what has happened in the past. Nothing is specific in the stock market. Always use stop-loss orders when investing!
Action To Take: Continue to hold stocks and buy dips.
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