8 Bullish Reasons Why the Stock Market Still Looks Good

Guild Investment Management |

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At Guild Investment Management, in order to determine the direction of the markets, we keep an ongoing and daily-updated model of the global, social, technological, political, and economic trends that will shape investment opportunity.

This is a time-consuming process that involves a great deal of study and monitoring of events in many sectors of the world. Let’s take a quick look at the variables that we rank as being the most significant.

Macro Trends Rated 1 to 10 -- With 10 the Most Positive

1. Fear of a Meltdown in China

Contrary to fears voiced in the press, in reality China’s banking system is not melting down. Its GDP growth rate is probably 6% rather than the 7.5% they advertise -- but 6% is very respectable, and far better than any other major economy in the world.

China’s banking system is strong, but its local government financial activities have been irresponsible through the over use of LGFVs (local government financing vehicles). Its shadow banking system of brokerage-house issued trust and other investment vehicles is a huge bubble. In order to strengthen economic growth, China has in the last two months added 700 billion Yuan (almost $44 billion) to the banking system. We have no doubt that more will be added if necessary to keep economic growth strong in 2014.

In our opinion, LGFVs, trust products, and other investment products issued by brokers and insurance companies are a large weak point. These investment products do not directly affect the Chinese banking system—although banks sell them or help organize them, the banks have not guaranteed them. These products do affect individual Chinese investors, and one day, many of these investment products will go bankrupt, causing large losses to the unwise individuals who bought them.

The bankruptcy of these vehicles will not have a major impact China’s banking system, but they will have a large effect on the psychology of investors. Many of these investors are naïve, and will have thought that they had purchased a relatively safe product. Instead, they will have lost their invested money.

Our verdict: a rating of 6.

2. Fear of a Recession in Europe

Germany continues to live in the past, fearing a return of the inflation that plagued Germany in the 1920s -- which many believe set the stage for the rise of the Nazi party. For Europe to grow, Germany must relent and agree to some form of bank restructuring, and to some form of quantitative easing.

Only in this way will they continue to grow and be able to emerge from the economic malaise into which they seem to be falling. The good news is that France and Italy are working together to push Germany to accept QE.

Further positive news is that the U.K. monetary tightening has been delayed, probably until 2016.

Our verdict: a rating of 4.

3. Fear of Stagnation in Japan

Japan has made headway in breaking away from their long held deflationary behaviors and to begin to take action to expand economic growth. Prime Minister Abe is strong in his resolve, with a plan to delay a sales tax increase, provide more QE, and weaken the Japanese Yen. The country is beginning to speed the breakout of its multi-decade economic malaise.

Our verdict: a rating of 5, up from 2.

4. Fear That Growth Will Stagnate in the U.S.

U.S. growth is probably in the 2.5 to 3.5% range before inflation. Industrial growth and employment are improving. Wage increases will be seen in the near future.

Inflation is moderating, and reported GDP including inflation will be in the 4% range in 2014, and a bit higher in 2015. This moderate GDP growth in the U.S. is adequate, and 4% nominal GDP growth will lead to a growth of corporate profits in the 5 to 6% range in 2015. Additional positive news: In speecheslast week, four members of the Federal Reserve’s governing committee indicated that there will be noincrease in U.S. interest rates until 2016.

Our verdict: a rating of 6.5.

5. Wars and External Disruption

The Islamic State (IS). It appears that belatedly the U.S. is developing a larger cadre of allies and a more coherent strategy for dealing with IS. Although U.S. generals continue to warn that some troop commitments must be made to defeat IS, their power and mobility has been weakened at least temporarily.

Iran. The west continues to let Iran pursue nuclear weapons -- but we find ourselves at least somewhat allied with them against IS.

Russia. Russia will continue to move to reassemble large parts of its former empire. They will go back into Ukraine, and will threaten the Baltic states and some of their southern and western neighbors. Things are quiet with Russia in the short term, but may get worse in November.

Other areas (China and elsewhere). Currently quiet.

Our overall verdict: a rating of 5, up from 3.

6. Market Sentiment

Sentiment and fear has been at high levels, and U.S. and world stock markets are oversold.

Pessimism dominates media reports and the psychology of many investors. October through April have been the best 7 months of the year for stock market increases over the past 100 years. Our rating is inverse --more pessimism and a more oversold market ranks higher.

Our verdict: a rating of 8, up from 5.

7. Valuations Are Reasonable

U.S. stocks are now selling at about 17 times 2014 S&P 500 earnings of $118.

If earnings are up 5% in 2015, U.S. S&P 500 earnings are going to be about $124 -- implying a price-to earnings multiple for the S&P of about 16.5. Peak stock market earnings at a major market top historically usually exceed 21 times earnings, so we have at least 20% more upside if the market is to reach an ultimate top. We do not think such a top will happen before 2016.

Our verdict: a rating of 6, up from 4.

8. The U.S. Dollar is in an Intermediate and Long-Term Bull Market

This will attract money into U.S. bonds and U.S. stocks. Many major bond market participants have been expecting interest rates to rise as inflation rises. However it is obvious that in the near term inflation will not rise. We believe that foreign money will keep running to the U.S. Dollar, providing continuing demand for U.S. bonds and stocks.

Our verdict: a rating of 7.

Totaling our rating system: below 5 negative, above 5 positive. 8 categories, 47.5 total rating points, is an overall rating of about 6. Conclusion: the U.S. is in positive position for a stock market rally. We suggest that technology and biotech growth stocks are attractive areas for investment.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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