6/3/2011 - Equities Poised for Significant Summer Rally

6/3/2011 - Equities Poised for Significant Summer Rally

Written By: Matthew Xiarhos
Categorized in: NEWSLETTERS

Equity Market Overview

My long-term outlook for the market remains positive. The short and intermediate term outlooks are also quite excellent right now. We are about to enjoy an excellent summer rally.

Two factors lead me to conclude that a significant rally in stocks is imminent. First, investor sentiment is highly anxious as occurs near market bottoms. Second, market internals developed a positive divergence with prices when equities declined earlier this week. Let's take a more in depth look at each...

Remarkably, even with equity prices near all time highs for this bull market we are seeing very high levels of anxiety. In fact, the AAII weekly survey of market outlook among its members shows that there are currently more Bears (33%) than Bulls (30%). This ratio of slightly less than 1 frequently occurs near intermediate-term market bottoms. The most recent similar reading occurred after the horrible tragedy in Japan in mid-March

Market internals are also exceptionally robust. However, as I wrote last month, the focus and strength is moving away from small-cap stocks and up the capitalization ladder towards mid and larger-cap stocks. As one reviews the internal strength of each area there is a commensurate increase with larger capitalization stocks; small-cap being weakest and mega-caps being the exhibiting the strongest internals.

Technically, the market has just exhibited a positive divergence with market internals. What this means is that prices have recently gone to new low when we compare the last swing low early last week with the recent lows this week. However, technical indicators of market internals like the McClellan Oscillator, which measures advancing and declining issues, did not move to a new low in parallel with prices. Such resiliency in a technical market indicator, especially during bull markets, is usually a textbook signal that a recent correction/consolidation is over and the rally is ready to resume.

I continue to recommend investors use a "buy the dips" mentality and not be shaken from that position. There is no evidence of long-term deterioration in stocks that would be a harbinger of a long-term or more serious decline. In fact, quite the opposite condition exists suggesting that the bull market advance is healthy and will continue higher in spite of challenging economic and political climes.

US Equity Markets (Equity Style Model)

Within the Equity Style universe there continue to be some interesting developments. Small-cap Growth stocks , which have been leaders since the beginning of this bull market are starting to show some signs of tiring and topping out. While the relative strength of this area has not yet changed to a downtrend it has lost considerable momentum and appears poised to turn lower relative to other areas.

Mid-Cap Growth is apparently the sweet spot right now offering both better liquidity than small-caps while retaining some "growthy" characteristics investors are looking for. Without a question this is the strongest area in the Equity style arena.

Large-cap Growth stocks appear to be forming a bottom with respect to their relative performance. They have under-performed their Small and Mid Cap Growth counterparts by a significant margin this entire bull market.

The value area, regardless of capitalization, continues to struggle. This suggests that investors are willing to pay a premium for more both more solid and more predictable earnings streams; hardly a surprise in such an uncertain economy.

International Equities

International Equities did not decline in unison with domestic equities this week which has led to a positive spike in their relative performance. Coupled with the developing nascent strength that I have been discussing for some months I am finally feeling more encouraged about this area.

While the recent resiliency of International Equities this week is a step in the right direction it isn't quite enough evidence to suggest that they have resumed their leadership role. No better test of that leadership ability will come when/if the anticipated summer rally develops. If the rally develops I would fully expect to see International Equities outperforming their domestic counterparts.

The Regional model is long Asia, Europe and Japan.

Investment Grade Bonds

We continue to be long International investment Grade Bonds. The renewed weakness in the US Dollar (and commensurate strength in foreign currencies) provides a nice tail wind to our position.

High Yield Bonds

We continue to be long High Yield Bonds.

Real Assets / Inflation Hedges

Since our last report, the model has switched its position in Commodities to Gold Bullion and continues to be long REITs.

Currencies

We continue to be long the Swiss Franc.

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