Stock Bulls See More Reason for Optimism

 

Longtime stock-market bulls are seeing even more reasons to stick to their guns.

In the past week, the European Central Bank took aggressive steps to ease policy, the May employment report showed a spring thaw for the U.S. economy, and beaten-down small-company and technology stocks staged a rebound.

That has given bulls even more reason to be optimistic. They argue that, short of a sudden shock, threats to the five-year-long bull market have been diminishing, not increasing.

Jeffrey Saut, chief investment strategist at Raymond James, was one of the few Wall Street strategists to correctly turn bullish in March 2009 and remains positive on the outlook for stocks.

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"It's been very resilient, but that's what bull markets are," said Mr. Saut. "The bull market is going to extend for a lot longer than anybody thinks."

Mr. Saut said the bull market could be derailed by "a policy mistake in D.C., or inflation ramping up [substantially], but I don't think any of those things are going to happen," he said.

While there is always the possibility of some unexpected event knocking stocks into a tailspin, he said, "I don't know how you invest based on that."

After rallying 30% in 2013, the S&P 500 has tacked on 5.5% this year, rising 1.3% in the past week. With Friday's 0.5% gain, the S&P 500 has hit 18 daily record closes this year. Throw in dividends and the S&P is up 6.4%. The Dow Jones Industrial Average is up 2.1% this year.

The broad market has weathered the Federal Reserve paring back its easing efforts, a steep selloff in emerging markets and the collapse of many richly valued small-company and technology shares.

But emerging-market stocks have bounced back strongly, as have corners of the U.S. market that entered a deep swoon in early March.

The Russell 2000 index of small-cap stocks, for example, fell nearly 10% on a closing basis from a March 4 record high. But over the last three weeks the index bounced 5.6% and last week rose 2.7%. The Nasdaq has also had a strong rebound, rising 6.1% in the past four weeks.

Seth Masters, chief investment officer at Bernstein Global Wealth Management, a unit of $457 billion asset manager AllianceBernstein, said the recent selloff in high-growth biotechnology and Internet stocks showed investors are less willing to pay high prices for stocks lacking strong underlying earnings.

The broad market has weathered the Federal Reserve paring back its easing efforts, a steep selloff in emerging markets and the collapse of many richly valued small-company and technology shares. Above, traders work on the floor of the New York Stock Exchange last month. Associated Press
 

"Investors are becoming more sensitive to fundamentals and prices and that's a good thing," he said.

In 2012, Mr. Masters called for the Dow to hit 20000 by the end of the decade. With the Dow just 18% away from his target, Mr. Masters said he wouldn't be surprised if the forecast pans out a few years early.

Mr. Masters is advising his firm's portfolio managers to hold larger positions in stocks that benefit most from a growing economy, and financial companies in particular.

Lending confidence to the bulls is that stocks are keeping a closer pace with earnings than they did last year. Analysts expect profits among S&P 500 companies in the first half of this year to rise by 3.8%, according to FactSet, a pace not far from the index's year-to-date gains.

That is in contrast with 2013, when stock prices rose much more quickly than earnings, leading to a jump in valuations.

Last year, the S&P 500's forward price/earnings ratio rose to 15.3 from 12.6, according to FactSet.

That climb has slowed dramatically, leaving the S&P's P/E ratio only slightly higher at 15.5 today. Over the last 10 years, the S&P has had an average P/E of 13.8.

"The market is trading rationally," said Jim Russell, senior equity strategist at U.S. Bank Wealth Management, which manages about $120 billion in Minneapolis. "That does give us a sense of comfort."

Another reason for continued bullishness is the slow-but-steady pace of economic growth.

"The economy is going to be getting a bit better, but we're not going to have runaway growth," said Robert Doll, chief equity strategist at Nuveen Asset Management, which manages roughly $120 billion.

Mr. Doll said the harsh winter likely led to pent-up demand in the economy. Following the 1% contraction in the first quarter, he expects the U.S. economy to grow at an annual pace of 4% in the second quarter and more than 3% in the second half of 2014.

Against that backdrop he has been buying shares of companies that benefit from stronger growth, such as industrial and technology shares.

At the start of the year, Mr. Doll predicted the S&P 500 would hit 1950 by year-end—less than a point above Friday's closing level—but now says that target is likely to be exceeded.

At the same time, growth isn't expected to be so fast that the Fed would pull back on its stimulus efforts sooner than anticipated. Fed officials have said that while they are "tapering" bond purchases, they plan to keep interest rates parked near zero at least into the first half of 2015.

"Growth is continuing at a moderate pace, but not fast enough that would create this inflation problem," Mr. Masters said. "If anything, inflation is lower than the Fed would like," which should mean continued loose monetary policy.

Many of those staying positive on stocks say bulls still don't get much respect.

"When I give a speech about the market, no one says, 'What if this goes right?' They say, 'What if this goes wrong, or that goes wrong?' " said Mr. Doll. "We have a disbelieved bull market."

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