More Buyers Than Sellers

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There is an endless parade of “experts” that will go on TV or send you a free copy of their newsletter telling you emphatically what is going to happen in the market. They will also tell you why what is happening shouldn’t be happening and give you an often complex reason for why things are happening. At the end of the day there needs to be more buyers than sellers. If that is the case then the market will go higher. If things tip to the other end of the spectrum and the marginal trade is a sell, the market goes lower.

There is a guy on TV right now telling me that the market is not going up on fundamentals and that “it has moved too far too fast”. I never really know what these sorts of statements mean. Please always remember, there is nothing more fundamental than price. Many of the things that people call fundamentals are oftentimes just crutches. Ways “experts” can explain away mistakes.

What are the important fundamentals? What makes stocks go higher? The gentleman said there is not enough growth in the economy right now so the market should not have experienced this move higher in 2013. Let’s look at this statement and try to think it through. Let’s agree with him and say that there is not enough growth in the economy. What comes with slower growth? Low interest rates. With low interest rates the hurdle rate for stocks to get over is much lower. If bonds are paying a low rate of interest it makes stocks inherently more attractive. The relationship between interest rates and stock dividends has changed dramatically over the past several years. Many of the blue chip stocks pay dividends well in excess of what an investor can receive in 10-year bonds.

What else comes with a slow growth environment? People will pay for companies that can offer attractive growth prospects. Is it reasonable to expect growth rates from major blue chip Dow and S&P 500 companies in the 6%-7% range? They have done that for several quarters now when you look at reported earnings. If you add a 3% to 4% dividend to that growth you can find a slew of companies that could possibly give you a total return of 9%-10%. Compare that sort of total return to bond yields that are at historically low levels and the run in stocks is not so incredible to fathom.

We have seen external factors like the European bond crises and the fiscal cliff nonsense derail things over the past few years. But, when was the last time you saw an “expert” come on TV and guarantee the breakup of the European Union and riots in the streets? Those geniuses were lined up to go on CNBC and say just that in the not too distant past.  Just in November of 2012 there was a horde of commentators going on TV telling you the end is here based on the catastrophe that is the fiscal cliff. Are those guys returning your calls now if you placed an investment with them based on their doom and gloom scenarios?

When will the advance end? When there are more sellers than buyers. When will we know that is happening? When the major averages begin to roll over and break down through key moving averages. When the number of stocks in basing or advancing patterns begins a sustained decline it will tell you the jig is up.

Right now the technical condition of the market remains in great shape. 82% of the companies in the S&P 500 are in basing or advancing positions. 78% of small cap stocks are also in sound technical condition. The market held above the support levels I gave you the last time and bounced higher. The Dow and Russell 2000 have already moved out to highs. We need to see the S&P 500 confirm this move and close above 1576 to avoid a negative divergence. Here are the support levels for the S&P 500/Dow/ NASDAQ/Russell 2000: 1532/14,150/3215/933. As I've said before, keep the “experts” to a minimum.

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About Thomas J Smith CFA