Friday, September 28, 2007

Stocks Slightly Lower into Final Hour on End-of-Quarter Profit-Taking

BOTTOM LINE: The Portfolio is slightly higher into the final hour on gains in my Networking longs, Retail longs and Internet longs. I have not traded today, thus leaving the Portfolio 100% net long. The overall tone of the market is slightly negative today as the advance/decline line is mildly lower, sector performance is mostly negative and volume is below average. High Yield Corporate Bond Funds saw $405 million in inflows this week, the greatest amount since June 1, 2005, which is a big positive. Once again, domestic mutual funds, which have been completely shunned during this bull market, saw outflows while non-domestic mutual funds saw inflows. Keeping the public afraid of U.S. stocks remains one of the bears' most successful weapons. I still believe the eventual participation by the general public in U.S. stock gains will help contribute to the "mother of all short-covering rallies." The proliferation of hedge funds and significant increase in turnover by many other funds since the bubble burst in 2000 usually leads to mild profit-taking at quarter's end, in my opinion. Bespoke Investment Group recently said that, since the fourth quarter of 2002, the S&P 500 has averaged a -0.01% decline over the final two days of the quarter and a -0.28% decline on the final day of the quarter. The Fed's Lockhart made several comments this morning. He painted an economic picture of mildly below-trend growth and moderate inflation, which is what I have been saying for some time. He said he expects third-quarter growth to come in at 2.5% and fourth-quarter growth to be lower. I have been saying that growth would average around 2%-2.5% during the second half of the year, notwithstanding fed funds rate cuts. He also said the Fed's Sept. 18 rate cut action was a "tactical move" to reduce the risks facing the economy from the rout in financial markets that gathered momentum in August. Fed funds futures now imply an 84% chance of a 25-basis-point fed funds rate cut at the October meeting. The AAII percentage of bulls rose to 49.4% this week from 39.2% the prior week. This reading is now modestly above average levels. The AAII percentage of bears rose to 34.2% this week from 31.7% the prior week. This reading is now above average levels. Moreover, the 10-week moving average of the percentage of bears is currently at 39.4%, a high level. The 10-week moving average of the percentage of bears peaked at 43.0% at the major bear-market low during 2002. The 50-week moving average of the percentage of bears is currently 36.8%, an elevated level seen during only two other periods since tracking began in the 1980s. Those periods were October 1990-July 1991 and March 2003-May 2003, both of which were near major stock market bottoms. The extreme readings in the 50-week moving average of the percentage of bears during those periods peaked at 41.6% on Jan. 31, 1991, and 38.1% on April 10, 2003. We are currently very close to eclipsing the peak in bearish sentiment during the 2000-2003 market meltdown, which I still find astonishing, notwithstanding the recent correction. The S&P 500 is 108.6% higher from October 2002 lows and is only 1.3% lower from its recent record set in July. While the percentage of bulls has rebounded recently, I would have to see several readings in the high 50s-low 60s before becoming concerned. US stock mutual funds have seen outflows for most of the past 5 years, there has been an explosion in low correlation/negative correlation US stocks strategies, there have been huge spikes in gauges of investor anxiety over the last couple of years on relatively mild market pullbacks, a fairly large chunk of the public generally hates US stocks and says they won’t ever invest in them again, the mainstream press obsesses with what is wrong or what could go wrong and long-term investors are denigrated, while day-trading is championed as a crash is always seen as just around the corner. I continue to believe overall investor sentiment regarding US stocks has never been worse in history with the S&P 500 right near a record high, which bodes very well for further outsized gains. I expect US stocks to trade modestly higher into the close from current levels on short-covering, bargain hunting, less economic pessimism, lower energy prices and investment manager performance anxiety.

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