Why the Stock Market’s Rise Is Important

Tuesday, October 5, 2010

Why did the US stock market go up in September? Mainly, because some heavyweight investors decided it was time to buy. That reason may sound obvious, but, in this investing environment, it is significant. More important than their actions are their motives.

The Wall Street Journal provided the insights in “Paulson and the Bulls Bounce Back” (By Gregory Zuckerman, Monday, October 4, page C-1).  (All quotes below are from this article.)

The article cites six reasons that “A number of hedge-fund investors have become more bullish in recent weeks.” The first two are trading oriented explanations that could just as easily reverse in the near future: the euro’s rally and the Federal Reserve’s expected continued policy of keeping interest rates low.

However, the other four are indicative of a real change in thinking – away from macro/global uncertainties and towards long-term growth opportunities.

1. A newly adopted focus on company performance

“… many are attracted by companies that continue to churn out impressive amounts of cash flow, making their shares and debt attractive….”

This is what we’ve been waiting for – a shift to company fundamentals.

2. A view that downbeat investors have taken prices down too much

With this new focus, the heavyweight investors moved away from the global/macro uncertainties that hit the stock market this spring and again in August. With this shift in thinking, “some … viewed investors as being too pessimistic this summer…” and took advantage of the low prices.

3. An evaluation that “safe” bonds are less desirable than stocks

These investors don’t necessarily think bonds are in a bubble. Rather, they believe a comparison of bonds and stocks now favors the latter: “There is a recognition among some hedge funds that ‘buying a 10-year U.S. Treasury at only 2.5% leaves little room for appreciation and plenty of risk to the downside….’”

4. A recognition that new trends can take off

This observation is the reason investors need to be careful about “waiting for the dust to settle.”

“Even some investors with a bearish view of the market’s long-term fundamentals have been buying shares lately, worried that they would be left behind if the market launches a year-end rally.”

So… The apparent trend shift we discussed last week (*) appears to have some strong supporters. Therefore, investors underweight in US stocks should at least reevaluate their own thinking. Now is one of those times when deciding to postpone making a decision could result in a missed opportunity.

(*) Below are the three articles I wrote last week:

  1. WSJ Accidentally Identifies Macro Investing’s Probable End of the Line” (September 28)
  2. How to Profit from Trend Changes” (September 29)
  3. New Investment Horizon Ahead – Four Steps for Adjusting Our Focus and Strategy” (October 1)

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