Although we only use sentiment analysis and other technical tools as one measure of overall stock selection process, shorter-term investing can often be very profitable using sentiment indicators as a guide since they indicate where the bulk of the money is currently placed and therefore where the mostly likely direction of stocks will be if events don’t unfold as generally expected.  That clearly applies, as shown in the chart below, to recent market action where the Bull/Bear Ratio at the end of August went back to lows not seen since the summer of 2009 just as the market was headed into the ‘dreaded’ September, historically the worst month for stocks each year.  All that August pessimism gave rise to short-sellers, who borrow a company’s shares to sell, then buy them back later in hopes that the stock falls and they can pocket the difference.  Short interest on the New York Stock Exchange rose 4.9 percent in August, which was the biggest jump since March 2009, the same month the market hit its multi-year lows.  With all those short positions in stocks outstanding, there is always a chance that those short sellers will get forced to buy back or ‘cover’ their positions as the stock market rises and the losses increase.  This rush of ‘short-covering’ has been one source buying strength that moved stocks higher last month and could easily continue into the 4th quarter.

While stocks have had good gains in September and sentiment has improved, the signals coming from both the stock market and the economy continue to be mixed, which is why stocks have been somewhat ‘range bound’ for most of the year. Transport stocks such as rails have been strong, generally a positive re-enforcement of general index strength.  But semi-conductor stocks, another key indicator of economic momentum, have been weak while Financial Service stocks have also failed to rally along with the overall market, another sign that the current rally lacks broad-based support.  But our view continues to be positive and we believe that the market is experiencing a recovery similar to the one in the 2003-2007 period, when economic growth moderated but stocks continued to grind higher.

In terms of the US economy, still the world’s largest and most important, it’s nice to know that the worst U.S. recession since the Great Depression has ‘officially’ ended.  According to a recent report from the National Bureau of Economic Research (NBER), the US emerged from its recession in June of 2009.   Yes, it’s official according to the NBER!  The 2007-2009 recession, which wiped out 7.3 million jobs, cut 4.1% from economic output and cost Americans 21% of their net worth and marked the longest slump since the Great Depression ended in June of last year.  The end of the recession occurred 18 months after the economy began sliding into a downturn in December 2007.  The next-longest postwar slumps were those of the early 1970s and the early 1980s, both of which lasted 16 months.  But stock market investors were already fully aware of this fact long before the NBER made it official.  The market bottom seen over 18 months ago was really an assessment by investors that the recession was about to end.

One reason why stocks are basically unchanged in 2010 is that mutual fund investors have yanked money from equities, even as reasons for optimism accumulate.  Almost $57 billion has been withdrawn from U.S. stock mutual funds, the most during any four-month period since 2008.  Moreover, the CBOE Volatility Index shows concern has never been higher that shares will plunge, Bloomberg Businessweek reported in its Sept. 20 issue.  Clearly the public is not participating in the stock gains of the past year and are still recuperating from the market’s severe plunge in 2008, the second major bear market in the last ten years.  But indicators such as cash flow and dividend yields suggest equities are cheap, and North American companies are forecast to post the fastest profit growth since 1988.  Free cash flow produced by companies outside the financial industry represented 6.8 percent of their stock prices last month. That’s the highest since 1960 when measured against the average investment-grade corporate bond yield,

One of the big reasons that investors remain worried about the stock market, though, is because consumer confidence remains exceptionally weak, with the most recent data showing another downturn.  This weakness, in our view, has been driven by the lack of new job growth in the US during the economic recovery that started last year.  After losing almost 8 million jobs during the recession, the American economy has only brought about 1.5 million of those workers back onto payrolls since emerging from the recession.  We need to point out that this shouldn’t surprise anyone.  Companies went through the worst downturn since the 1930’s and were on the verge of a financial market collapse in 2008 that could potentially have sent the global economy into a multi-year recession.  When Corporate Boards sat down to meet in late 2008 and weren’t sure if Morgan Stanley would open their doors for business next week or whether GE Financial would survive as a credit entity, they didn’t just slow down their spending, they become like a ‘deer in the headlights’, stopping spending altogether until the situation started to improve.  So it’s not at all surprising that companies have been reticent to spend and hire and have instead built up their cash levels to their highest level ever!

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