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Flexible Plan Investments

It’s Super Bowl week and so, of course, the thoughts of many are on the big game and the sport of football. Looking back on the subject, I think one of the most pleasant memories of playing football was being in the huddle and hearing the quarterback bark out “Go long.” You knew then that something big was possible, as one of our numbers would be able to run full throttle toward the end zone and have the opportunity for a game-breaking reception.

This year has the same feel in the financial markets. Many of the longer-term indicators seem to be lining up for a bullish year.

As I said last week in an article in which I made the technical case for a positive 2012 based on earnings, the economy and interest rates, the short term could be just the opposite – we saw a little of that expected market weakness last week, and there is more follow through today.

In the short term we have to acknowledge that the market is overbought. By that we mean that the market indices have been up strongly since mid-December. Markets rarely go straight up and often need a period of time to regroup even in the midst of a market rally.

Secondly, earnings, which have propelled the market higher since the March 2009 turnaround, have not been beating expectations in the current reporting period (that still has a little more than a week to go) as significantly as they have since that market bottom. Earnings, revenues and company guidance, while on balance still positive, are the weakest they have been since the big-picture recovery rally began in ’09.
And although economic reports in the intermediate term have, more often than not, surprised to the upside, in the last week or so we have seen a divergence from this tendency. For example, last week, of the thirteen economic reports received, eight failed to match economist projections.

The GDP numbers (Gross Domestic Product – the value of all goods and services produced by our economy) released Friday were a case in point. Economists had convinced the street that an annualized rate of increase of 3% to 3.1% was likely. That’s a pretty big increase from the third quarter’s 1.8% increase. But then the report disappointed, as only a 2.8% rate of growth was disclosed.

We should be used to this, as this recovery is the most drawn out since the Great Depression. For every quarter since the financial crisis in 2008, the GDP growth number has lagged behind the median growth number for the equivalent post-recession period since WWII.

Median GDP Growh Following Depressions
Source: Bespoke Investement Group

Of course, as we demonstrated last week, this has been the case on other economic indicators. The Wall Street Journal recently highlighted this as well:

Growing but slowly
Source: Wall Street Journal

So, with these short-term concerns for the direction of the market, why are we still long-term bullish? The biggest reason comes under the heading of valuation. Valuation is a term used to encompass all the measures of whether or not the market is overvalued or undervalued. These indicators are the underpinnings of Fundamental Analysis – the Warren Buffet view of the market. While I am in the main a technical analyst, one should always have an eye on the fundamental considerations because so many investors follow them, and to put the technicals into perspective.

Here’s a table of some of the more popular valuation indicators:
Valuation Indicators
Source: Flexible Plan Investments

Obviously, by any measure stocks are undervalued. The gains needed in 2012 to bring them in line with just the historical averages are quite respectable.

Of course, you can’t just look at the fundamentals in a vacuum. You have to compare stocks to the alternative. Bonds have always filled that role versus equities. And on that measure we can see that whether you compare against treasuries or corporate, stocks look quite a bit better.

S & P Earnings
Source: Bespoke Investement Group

Returning to the world of technical analysis, the picture looks quite positive as well. Even with today’s decline, it appears that one of those Golden Crosses we often reference is about to appear. This occurs when the 50-day moving average of the S&P 500′s daily value crosses above the 200-day average.

While the last time this occurred did not pan out (10/22/10 Golden Cross to 8/12/11 Death Cross) and generated a small loss (0.36%), since 1961 22 out of 27 trades have been profitable, with the average gain being eighteen times the average loss. Since 1999, four out of five trades have been profitable, the last time’s small loss being the lone exception. Compared to that 0.36% loss, the four gains were 16.6%, 8.03%, 13.05% and 14.24%.

Investor sentiment remains mixed. Some indicators show over enthusiasm, while others are much more moderate. I do worry that the fact that only 18% of the investors in the latest survey are bearish is demonstrating too high a degree of complacency.

Bearish Sentiment
Source: Bespoke Investement Group

However, while this supports my short-term correction scenario on a contrarian basis, the mixed nature of other measures suggests that the market can rally further.

Finally, we move this week into the month of February. Most commentators have pointed out that February on average is a negative stock market month, competing with May and September for the “worst” designation.

Still, when you look at how February does after a positive January, a different picture emerges. Since 1950, January has been up 36 times. The subsequent February has seen the stock market gain ground 24 times – two-thirds or 66.6% of the time.

Perhaps more importantly, after a positive January, stocks have finished the year higher more than 80% of the time, with average gains better than 10% for the remaining eleven months. As goes January, so goes the rest of the year!

While both quarterbacks in Sunday’s Super Bowl are known for their short passing game that just drives defenses nuts, I have a feeling that the game will be decided after one of the teams huddles and their quarterback barks “Go long.” In any event, whether it’s a winning play or not, both teams will be glad they have a defense on the field throughout the game. And you should, too, in today’s financial markets, regardless of my long-term market outlook.

All the best,



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