Profit Taking and Recovery

     Stocks continue to do well as investors continue to put some of their idle cash to work in stocks.  That is not a new story, nor for that matter is it one that is winding down.  Look for buying to increase and prices to move still higher for the same reason they've done well for a few years, i.e. there is no alternative.     

     Investors shrugged off May's profit-taking triggered by Bernanke's comments about Fed bond buying to which people overreacted.  The Fed must have been surprised by the quick sell-off in both stocks and bonds, because in appearances since May Bernanke and others made it clear that short-term rates won't be rising for years.  Recently he said that the 7.6 percent unemployment rate "overstates" the health of the economy and argues for more accommodation not less and low rates for a long time.  And he's right.  Look beneath the headline numbers for hiring (mostly part-time) and the picture is bleak.  The broadest measure of the labor picture shows that 14.3 percent are either out of work or in a part-time job when they really want to work full time. 

     Bonds have not fared well as stocks rallied.  Treasurys have been especially hard hit and with good reason since they had been the most overvalued.   

     What catalyst could drive stocks higher?  A slight rise in the market's price-earnings ratio would do it, that on top of a small boost in earnings estimates for next year that will be reflected in prices before year-end.  There is another factor.  Hedge funds and institutions have been underinvested in stocks for years.  There is $2.6 trillion in money-market funds, two-thirds held by institutions.  The cash-heavy professionals are returning, though slowly.  Individuals control one-third of the money-market trillions.  Some are re-discovering stocks as well.  Buying by pros and amateurs will support the market when profit-taking occurs and propel it higher at a rate faster than earnings growth would dictate.  Presto!  Multiple expansion.

     Bottom line: As long as alternative investments remain unattractive (think years), stocks will do well.  They'll do best if GDP growth here and overseas picks up even if that makes interest rates rise, because profits would be rising, too.  That, plus some multiple expansion, is what many investors are banking on.  They'll be right.

David Vomund is an Incline Village-based fee-only money manager.  Information is found at www.ETFportfolios.net or by calling 775-832-8555.  Clients hold the positions mentioned in this article.  Past performance does not guarantee future results.  Consult your financial advisor before purchasing any security.