Broker Talk: Buy on the Dips

Skeptics of the market’s steep rally are pointing to negative indicators such as the rising unemployment rate as evidence that the market is over-extended. But unemployment numbers tend to lag an economic recovery, these brokerages say, and other indicators suggest the economy is actually gaining steam.

Who’s Talking: Liz Ann Sonders, Chief Investment Strategist, Charles Schwab

The Gist: Key economic indicators will continue to deliver better-than-expected results, which could catapult the economy forward through year-end.

Sonders likens current market conditions to “coiled springs” that could lead to greater-than-expected growth and an extension of the market rally. But the market won’t move up in a straight line, says Sonders. Instead there will be shallow and short dips in performance similar to what happened in the market at the end of September.

The dips, says Sonders, are a good “opportunity for investors who need to raise equity allocations up to target levels.” For example, a recent disappointing jobs report pushed the market lower but was followed by a reversal after other economics reports turned out better than expected. Sonders says she believes that trend will continue.

There are other indicators to be optimistic about. Media and investors often focus on the unemployment rate, she says, but the indicator is “perpetually lagging” and “typically doesn’t peak until well after a recession has ended.” However, on a more positive note, the inventory/sales ratio fell for the fifth consecutive month, to its lowest level since September 2008. Wholesale inventories fell for the 12th straight month in August and wholesale sales rose 1%. Plus, retail sales gained 0.4% in September, the first gain in a year. All these components put together make for a “popping” of the coiled spring, says Sonders.

As demand picks up, manufacturers will need to produce more, and having slashed inventories and workers during the downturn, that means they’ll need more employees. Additional hiring will hopefully convince consumers to be more confident, creating a “feedback cycle” to boost overall growth, says Sonders.

Sonders admits there is still a much to worry about the future of the market. A number of companies are issuing cautious guidance and some are reporting disappointing earnings. There’s also concern about the value of the dollar and the possibility of inflation and rising debt taking a toll on the stock market. But the pessimism actually keeps Sonders “relatively optimistic” about the market in the short-run, she says. Macroeconomic problems related to the dollar and U.S. debt may arise in the future, but it’s “unpredictable,” says Sonders, and the best way to fight unpredictability is a diversified portfolio.

Who’s Talking: Jeffrey Saut, Chief Investment Strategist, Raymond James

The Gist: After a seven-month climb in the equities market, naysayers are still calling warning of a “sucker’s rally.” But any upcoming market corrections will be short and shallow.

Saut says he finds it “interesting” that despite a tremendous rally in stocks and encouraging statistics, the “negative nabobs” are still calling this period a bear market “sucker’s rally.” The real suckers, says Saut, are the bears who “sat out” the seven-month rally in the stock market.

With credit spreads falling back to levels last seen before the fall of Lehman Brothers in September 2008, Saut says the S&P 500 could climb to at least 1200. There will eventually be a “healthy correction,” says Saut, but the main force in the market is “up.” According to Riverfront Investment Group, the level of selling on the market, as measured by its Selling Pressure Index, has reached a new 12-month low. As for the nature of the correction, so far the market corrections have been brief and shallow, largely because portfolio managers have kept too much cash on the sidelines and underplayed the “bull run,” he says. Now those fund managers have to contend with performance risk, bonus risk and job risk as they approach the year’s end (when year-long performance is measured). This is yet another reason to believe that stocks will be higher at year-end even with a potential short-term pullback, says Saut.

Those who point to unemployment as a sign of stock market losses should be reminded that employment is “at the back-end of the cycle” meaning that its uptick lags earlier signs of recovery. Even with 1) deflated consumers accounting for 70% of the economy, and 2) rising unemployment, Saut says economic recovery is driven by corporate profits, not consumption. The profits lead to investment, which fosters capital spending and eventually hiring. “That’s the typical sequence and we think it plays that way this time,” he says. Good thing corporate profits are surging.