Yesterday, the market broke out to a new five-year. Investors are shrugging off many nagging issues and a lack of attractive investment alternatives is pushing stocks higher.
Earnings season won’t be great. Revenues will be flat and profits will be preserved due to cost-cutting. Corporate balance sheets are strong and stocks are trading at a reasonable forward P/E of 14.
Alcoa posted a decent number and the reaction was subdued. This morning, Wells Fargo beat top and bottom line estimates and the stock declined. The strongest companies release early in the earnings cycle and the results will be better than feared. Asset Managers will not pile into the market, but they will be steady buyers on pullbacks.
Option implied volatilities are near historic lows and that is a sign of confidence. Investors are not afraid of the debt ceiling and they believe politicians will reach an agreement.
Europe is in a recession, but investors are focusing on growth in China. Yesterday they posted stronger-than-expected trade balances. We know that the new leadership will keep its foot on the gas pedal.
Credit concerns in Europe have also subsided. The EU agreed to a centralized banking authority. The details will take a long time to hammer out, but the market doesn’t care. Spain held a successful bond auction yesterday and PIIGS yields are stable.
Developed nations are running massive deficits and as long as central banks continue to print money, no one cares. Bond yields are at historic lows and Asset Managers are anxious to rotate out of fixed income and into equities.
This is not a growth story; it is the “new normal”. Massive debt levels are problematic and activity is sluggish. The market will move higher because stocks are the best investment alternative.
Here is the market forecast for the next few weeks. Major earnings releases will fail to excite investors. Resistance will hold and gradually buyers will warm up to strong balance sheets and good cash flows. The market will grind higher until the debt ceiling sparks fear in February. Politicians will argue and the market will decline as the deadline approaches. Republicans will ultimately cave-in and the market will rejoice.
The “can” will get kicked down the road and Democrats will have a blank check for a couple of years. Once the debt ceiling is extended, an excellent buying opportunity will present itself.
Look for choppy trading through next week. The bid should strengthen and will have an opportunity to go long.
I plan to take profits as the debt ceiling deadline approaches and I might buy VIX calls. The moves won’t be exciting, but the price action should be fairly consistent.