Are the Markets Going to Continue Up?

Mike Kauffelt, CIO and Tom Beilstein, Portfolio Manager

The Technical Viewpoint:

Right now the short-term technical indicators are mixed. The biggest negative concerns sentiment. The NDR Crowd Sentiment Poll has been a very good indicator of late. It hit “extreme pessimism” at 34% bulls or below on 7/23/02, 10/09/02 and 2/20/03. Each of these dates was near a relative low in the market. So, for almost eight months while the market was basing out, we had mostly chronic pessimism. Recently, after a strong market rally, the NDR poll hit 67% bulls, which approaches the average percent bulls at short-term sentiment peaks. So this contrarian indicator points towards a summer retreat in the market. Lastly, the American Association of Individual Investors reported an incredible 71.4% bulls versus 8.6% bears in their survey last week. This is an extreme contrarian indicator.

The positives show uncertainty in the sentiment indicators. As was mentioned above, the NDR Crowd Sentiment Poll has averaged 67% at the peaks, but it has risen above 70% on four occasions. So knowing the peak in optimism is not that easy, except in hindsight. All we know is that we are close. Plus, behavioral science shows that it takes longer to turn negative from extreme optimism. So it could be that we are near the peak, but could stay there for a while before turning pessimistic. Another positive for the markets is liquidity. For the 3rd straight month, in May, domestic equity mutual funds had rising customer inflows, yet did not use all the cash. Cash in mutual funds has risen from $91 billion in February to $102 billion in March, $115 billion in April and $120 billion in May.

Conclusion. The indicators seem murky right now as to the short-term direction of the market. Things should get clearer over the next few weeks when a majority of the companies in the S&P 500 report earnings.

The Fundamental Viewpoint:

Most of what the economy needs to start growing is in place. We have very low interest rates to help finance and refinance our corporate and personal debt. We have relative calm in the world and consumer confidence in the future has been rising since April. We have a big fiscal stimulus plan delivered by the government that will start to benefit most Americans in the months ahead. The one thing missing from the equation is job growth. Job growth continues to be stagnant with continuing losses in manufacturing jobs being offset by slow growth in service jobs. Once businesses get busy enough that they need to add workers on a consistent basis, the economy should progress in a manner that can help spur demand, grow profits and increase the tax base. The latter is important because although many of us are getting a break on our federal taxes, it appears that many states and cities across America will be increasing their taxes to offset deficits.

Conclusion. We remain confident that the economy will grow in the second half of 2003. However, we think that going forward, the market will be more volatile and gains will be harder to come by as the economic expansion may be uneven and many sectors of our economy may still suffer (airlines, autos, etc.) while others (technology, healthcare, etc.) start to prosper.

Source: Ned Davis Research