Could I be wrong on a sell off?

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If it’s good enough for the geese, whom I criticize for being misguided doomsday merchants at the moment, it has to be good for a gander like me!

What I’m saying is if I objectively criticize those who say a crash has been due for at least two years now, I have to be able to defend my own views for believing we can trust stocks for at least the next 12 months.

So, here goes.

The case for

In a nutshell, I’m saying stocks have a bit to run because:

  • We’re not in the euphoria stage of the stock market. Recall Sir John Templeton defines a bull market as: “Bull markets are born on pessimism, grow on scepticism, mature on optimism, and die on euphoria.” I think we’re in the optimism phase but there still is some scepticism around.”
  • The Fed and central banks, with their easy money supply policy and low interest rates, should keep stock markets rising as investors aren’t getting enough yield out of bonds and term deposits.
  • Economies such as the USA, China, Japan and, to a lesser extent, Europe are improving.
  • I believe the long, slow grind higher story for economies and stock markets because of all the above.
  • The third year of a US presidency historically is good for stock markets — could politicians engineer such a thing in America?
  • Companies earnings continue to improve and this justifies higher stock prices and this has been supported by Reuters on the current US reporting season.

“With 41% of S&P 500 companies having reported results so far, 68% have posted earnings that topped expectations, according to Thomson Reuters data, above the long-term average of 63%. On the revenue side, 62.1% have beaten analysts’ forecasts, compared with the historical average of 61%,” Reuters reported.

I rest my case but now I have to look at why I could be wrong!

The case against

Try these arguments:

  • Goldman Sachs cut US growth forecasts for the second quarter from 3.1% to 3% but JP Morgan has 2.6%, while Barclays is at 2.8% following a weaker than expected durable goods figure after economists fiddled with the results to take out some noise in the numbers. And durable goods are pretty good GDP indicators.
  • Wednesday brings an advanced reading on GDP and if the number is less than plus 3%, then the US economy contracted for six months — a technical recession! That could spook stock markets.
  • Europe’s reaction to Russia over the problems in Ukraine could lead to an economic problem and that’s when stocks would slide.
  • German business confidence is dropping and this economy sells 25% of all Europe’s exports and it comes as the region’s recovery is faltering more than I expected at the beginning of 2014.
  • Inflation might surprise on the high side, which could force the Fed, or make investors think it will force the Fed, to raise interest rates sooner rather than later and that would hurt stocks.
  • If the boom is over-worked by rates being too low for too long, then there could be a huge correction when it happens and so the timing of the rate rise will be crucial.
  • The IMF has cut world growth from 3.7% to 3.4% and while I don’t think they are great forecasters, a downgrade doesn’t help my bullish stance. (However, the 2015 view is for 4% growth and I like that.)
  • US employment has been very part-time and wages are not rising and that could hurt the US recovery as 75% of US GDP comes from the great American shopper. Companies such as McDonald’s and Amazon disappointed with their profit reports and that could be a worrying shopping indicator. (Against this, the number of Americans filing new claims for unemployment benefits fell to the lowest level in nearly eight and a half years recently!)
  • New home sales in the US have had two worse than expected months and the housing recovery is important to the economic comeback. In June, compared to last year, sales were down 11.5%. (Of course, if business investment took off to replace housing investment, then that would be good but business has not yet lifted its investment game in the US.)
  • Bond markets are a little worrying in that US yields should be rising (and prices falling) as the stock market heads into record high territory and it could mean smarties are cashing up. Against that, it could be those who think the US economy and Europe will underperform and will spook stock markets. (I think these players are wrong but I’m guessing, hopefully accurately!)

So what’s my conclusion?

I remain in the camp that believes a sell off is likely but dip buyers could stop a 10% correction. Why? Well, look at the Goldman Sachs’ note, which tipped three months of being “neutral” on stocks. It also said: “This makes the near-term risk/reward less attractive, despite our strong conviction that equities are the best positioned asset class over 12 months, where we remain “overweight.””

So, that’s the stocks’ view that supports me, and what about the economy?

The Reuters consensus shows annualized growth picking up to 3% in the April-June quarter, which makes me content about my economic view on the US, that it can dodge a technical recession and that future quarters will be over 3%.

Then we have this unbelievably easy money policy, low interest rates and market P/Es, which are not flashing out warning lights, with both company earnings and even revenue for US companies surprising on the high side.

I said on Saturday that I think the biggest risk that could come along to send stocks hurtling earthward would be a black swan or X-factor event, which by definition is unseeable.

I’m holding some cash for a sell off but all I will be doing if that happens will be bargain hunting for stocks I hold and like.

If you’re more nervous than me, play it like a fund manager and hold around 30% in cash and hopefully you can make some money on a 6-7% sell off but this is all guesswork and timing, which isn’t easy to get right.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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