Two Big Reasons to Believe the U.S. Stock Market Will Bounce Back

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There's been a lot of cheerless news coming out of Europe lately, and that's taken a toll on the U.S. stock market. But I want to take this opportunity to offer up some positive points and remind investors that it's still too early to declare the bull-market dead, and even more premature to fret over a new bear market beginning.

There are two key considerations that support a continued rise in U.S. stocks:

  1. Corporate profits have been strong and are likely to hang tough for the remainder of the year.
  2. And the recent market decline has been in line with previous bull-market corrections.

Let's look at corporate earnings first…

Corporate Profits on the Rise

Recent developments in Europe have largely eclipsed a solid earnings season in the United States.

In fact, some 78% of the 477 companies in the Standard & Poor's 500 Index to report first quarter earnings have reported results above analysts' expectations. And as a result of increased profitability, the forward four-quarter price-to-earnings multiple for the S&P 500 now stands at 12.6 – well under the long-term average multiple of 15 and the average from the previous 52 weeks of 14.6. 

Obviously, the big question is whether these better-than-expected results will continue.

Well, according to new research by UBS AG (NYSE: UBS), the chances are high that they will. The Swiss brokerage says that unlike revenue forecasts, which can be accurately predicted based on gross domestic product (GDP) growth estimates, accurately predicting earnings growth during an economic recovery is hard because of the boost from operating leverage.

With cost structures cut so deeply, a 10% jump in revenue has a much larger impact on the bottom line as fixed costs are spread over a larger revenue base. So that 10% revenue jump can result in a 70% earnings jump. But unless one has intimate knowledge of a company's operations, it's hard to estimate that jump with any accuracy. That's why analysts have consistently underestimated earnings over the past few quarters. 

So while earnings growth was impressive in the first quarter – with cyclical sectors reporting a 72% increase – current projections for double-digit revenue growth over the next year should be supportive of continued earnings beats so long as European cuts are not too drastic.

Now here's even more grist for the "just a correction" camp…

The "Just a Correction" View

Our friends over at Lowry's Research Corp. have told their institutional clients that the March 2009-April 2010 rally of 71% was the largest and fastest to follow a bear market in history. As a result, it generated an over-abundance of optimism, and thus deserved one of the sharpest and fastest corrections in history. Consider that the average 13-month rally at the start of a new bull market since 1942 has been 36%, or around half of the '09-'10 advance. 

Meanwhile, the current decline has amounted to a 10% decline for the S&P 500. Other major corrections within bull trends in the past fifty years included an April-Nov '71 decline of -16%, which then reversed to hit a new high two years later. And more recently, the Dow Jones Industrial Average fell 13% in the period ranging from Aug-Oct '07 and tumbled 11.5% from Aug-Oct '99. Overall, since 1960, there have been six corrections during bull markets of 10% or more, averaging just over 12%.

So, considering that the recent decline is within the limits of prior corrections, and follows a very overextended rally, Lowry's concludes that it's premature to believe that a new bear market lies dead ahead. Paul Desmond and his team believe that buyers will come back soon, and push the market to new highs.

One other timing view I'd like to throw at you comes courtesy of Bob Drach, a veteran investment researcher out of northern Florida who has shown an uncanny knack for calling bottoms over the past 30 years – and certainly in the past 12 years that I've been talking with him. He's not so hot with tops, but he typically nails nadirs.

Drach observes that tradable lows tend to form when more than 75% of high-quality stocks are lower than their levels of four weeks ago and a majority of his nine key data sets are positive. 

Using the S&P 500 as an imperfect proxy for quality, we can see that around 480 stocks in the benchmark index are down in the past four weeks, or 96%. And his positive data sets are U.S. Federal Reserve, macroeconomic, media, sentiment, professional positioning, non-professional cash reserves, technical and structural. 

Basically his model always leans in the opposite direction from the media and non-professional sentiment when prices reach extreme one-month lows, the Fed is accommodative, earnings are up, and professionals are net long in the futures pits.

Said the always-acerbic Drach this weekend: "There's nothing tricky. The data sets are basically monitoring the behavior of others for repetitive mistakes, usually emotionally induced. Basically, people are lured into beliefs that lack validity, and they manipulate themselves."

Well said. We'll take heed.

[Editor's Note: As the preceding market analysis demonstrates, Money Morning Contributing Writer Jon D. Markman has never been afraid to make a prediction.

What's more, Markman is usually right. With uncertainty the watchword and volatility the norm in today's markets, defensive investing is the way to go. However, given the competition, low-risk/high-profit investments will be tougher than ever to find.

It will take a seasoned guide to uncover those opportunities. And Jon Markman is that guide.

In the face of what's been the toughest market for investors since the Great Depression, it's time to sweep away the uncertainty and eradicate the worry. That's why investors subscribe to Markman's weekly newsletter, The Strategic Advantage: Time and again Markman has proven himself capable of seeing opportunity when other investors are blinded by worry.

Subscribe to Strategic Advantage and hire Markman to be your guide. For more information, please click here.]

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  1. Dan | June 4, 2010

    I generally have a positive attitude about the future – when I think long term. However, there is a short term influence that I suspect may have a negative influence in economic attitudes on the part of the media and general public. The housing rebates are no longer available as of April 30 for new home purchases. When the may and particularly the June data is released I would expect some "oh, woe, me" responses.

  2. Jeff Pluim | June 4, 2010

    Of course the earnings of many companies are up Jon. The downturn in the economy has given smart managers the opportunity to cut the costs necessary to maintain earnings. Tell me Jon, how were the revenues for the companies you refer to. That is the real indicator of where the market is going. Any half decent manager will maintain the bottom line by cutting costs. Big deal. But if you look at the BIG PICTURE Jon, you will see that this market cannot be forcast from graphs and what has happened in the past. There are things happening today that have not happened in the past, and so to try to project a bull market based on the past just won't work.
    Here are just a few things that you might want to consider when you are giving advice through your rose colored glasses:
    – With the only traders left in the market being the large "fast trading" banks and funds, there is no precedent in the past for this situation.
    – Record government deficits world wide.
    – Environmental disasters in the making.
    – A huge surge in radical Islamic followers. These people are not free market thinkers Jon, and if you look at the demographics of this growing Muslim movement, it might just scare the bejeebers out of you.
    – A massive movement in geopolitical and financial power to China and away from the USA.
    Jeez Jon, why don't you stop trying to pump sunshine up our butts and start giving us some real recommendations as to how to play the current situation.

  3. nohomehere | June 4, 2010

    The Dog is shaking and if your not dug in deeper than an alabama tic you will be thrown off ! information is quickly disseminated around the globe , yes the true values and equities "Look in to my eyes"( mesmer ) has been the decades mantra . Doesn't the world need, a true gauge of value instead of this side show of and carny talk . Their must be a high resolution of clarity . Focus , not hocus-pocus ! Many have espoused the virtue of Gold , in an attempt to seek value or Equity . A natural reaction, when caught by a current is to reach for the solid object. But some times our strength too grip is overwhelmed, thus no matter what, we are swept away with the rest of the debris . Gold and all commodities would seem like a natural reserve of value and in normal tides they would be . But this is a tsunami of insecurity of opaque opportunity of equity unable to enter ! The currency is not the problem in EU or any where else . Therefore , To solve this crisis , One must remove all imputed values and relinquish control to free market and transparency. Tell the printers of money to stop the press. A re-writing of the mark to market is needed, a fine tuning of sovereignty will ensue. faith will be restored . WE must needs avoid a Weimar event at all costs . those most extreme costs would still be inexpensive compared to the lives of so many lost due to world war!

  4. selvan | June 4, 2010

    Not enough.Give something More

  5. marco giacinto | June 5, 2010

    On June 4 you have written this article. On the very same day the Stocks Exchanges the world over were crashing…

  6. kiwichick | June 5, 2010

    every fundamental is looking very bad

    as the famous quote goes " only economists and madmen believe in continous growth"

    we are on the edge of the cliff

    the next depression will make the 1930's look like a picnic

  7. H. Craig Bradley | June 5, 2010

    MOUSETRAP or RANGE BOUND ?

    What if we are in a series of rallies but still in a long term bear market since 2007? Notice every time the DOW gets near 11,200 it goes back down (resistence level ?). Maybe the market will be up perhaps 11% by year end, but with such volatility, most individual investors won't necessarily be up by the same amount.

    If we are in a real bull market, then over time, we should eventually revisit the market highs of 2007, but right now, nobody expects that to happen. Continuing High Unemployment is a big problem and so is a lack of credit (loans). Banks are so tight they just are not lending the amounts they once were. In addition, most all Federal taxes are scheduled to increase beginning next year.

    Right now, it does not quite seem like a new bull market, and each "correction" fools more investors into believing a bottom is being "hammered out", once again. It appears we are range bound, but not sure of the limits of the index "range".

  8. Alan | June 6, 2010

    It's not only U.S market, it's global markets now are all down, and hopefully would all bounce back.

    The problem is people's fear again, and goverments action are slowly to solve current issues.

    Overall whoever can catch the opportunity, who'll get profit.

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