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The Bullish Case For Stocks


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Bullish On Stocks

With major stock market indexes making new record highs, is there still a bullish case to be made for stocks? Can stocks continue to move higher from record high levels?   It may be hard for many investors to accept, but one can still make a bullish case for stocks, even with the record highs and lofty stock valuations. The key is to think outside of the box regarding what the records highs really represent and take into consideration what may happen in the not too distant future in regards to corporate earnings. It is earnings that ultimately determine the direction of stocks, and therefore, earnings need to be the central part of any analysis regarding stock market direction.

The Bullish Case For Stocks | Make Adjustments For Inflation

One way that the bullish case for stocks can be made is by looking at major stock market indexes through the prism of inflation. The media loves to focus on previous stock market index highs without taking into account how inflation factors into stock prices. While the Dow Jones Industrial Average, Standards and Poors 500 (S&P 500) Index and NASDAQ Composite Index making new nominal highs makes good headlines and creates a splash in the media, surpassing previous highs that were set years ago does not tell the full story.

For example, the last time the NASDAQ Composite Index made a high just above the 5,000 level (5,046.86 to be precise) was during the dot.com bubble days of the year 2000. It took fifteen years for this record level to be exceeded. In April 2015, this previous peak for the NASDAQ Composite Index was eclipsed when the NASDAQ Composite Index raced above 5,100 on the back of a long bull market run and the incredible performance of its major component, Apple Computer (NASDAQ: AAPL).

Bullish

However, just breaching the former record level is not that great of an accomplishment. Since the NASDAQ Composite Index peaked at 5,046 in 2000, the overall economy has undergone fifteen years of inflation. While inflation has been relatively subdued during this fifteen time period, it is still a factor when determining inflation-adjusted record levels for stocks. In fact, the NASDAQ Composite Index peaked above the 6,300 level in 2000, when inflation since the year 2000 is factored into the index’s 2000 peak.

Taking into consideration the inflation-adjusted peak, the reality is that the April 2015 nominal high in the NASDAQ Composite Index above the 5,100 level is actually more than twenty-three percent lower than the 2000 NASDAQ Composite Index inflation-adjusted peak of 6,300. In other words, despite media headlines heralding a new NASDAQ Composite Index record high, on an inflation-adjusted basis, the NASDAQ Composite Index needs to gain more than twenty-three percent to make an actual new high.

How does this all relate to the bullish case for stocks?   It means that despite major stock market indexes making nominal new highs during 2015 that beat previous records, these indexes, and subsequently their underlying stocks, have room to move more than twenty percent higher before they reach the inflation-adjusted peak levels set during the dot.com boom that peaked in 2000. This is important information to understand, as is means the current stock market bull-run has room to continue higher.

The Bullish Case For Stocks | Other Reasons To Be Bullish

There are many ways to make the bullish case for stocks, even as stocks endure one of the longest bull runs in history and reach valuations that are well above the average historic price to earnings ratio (P/E ratio) of fifteen.

Bullish Case For Stocks

The main reason to be bullish on stocks for the foreseeable future is that central banks around the world continue to pursue easy money policies. With the exception of the United States, most of the central banks in important economies around the world are providing some type of monetary stimulus in the form of Quantitative Easing (QE). On top of this stimulus, central banks are maintaining unusually low interest rates, which is making stocks attractive investments in comparison to fixed price interest bearing assets that are based on central bank policies.

Another reason to be bullish on stocks is that corporate earnings, while taking a breather in the United States, continue to grow throughout the world. This is boosting world stock markets, even as the United States stock markets have trouble moving appreciably higher. While the first half of 2015 has been tough for United States domiciled companies’ earnings for a number of reasons, from the strong United States dollar to the crash in oil prices, these factors appear to be self-correcting. The second half of 2015 should provide a better earnings backdrop for United States based companies, which in turn should boost the stock market towards the later part of 2015.

The United States Federal Reserve is expected to start raising interest rates at some point during the second half of 2015.   While this will likely be bearish for stocks around the time that interest rates are initially raised, history tells us that the first two years interest rate increases is typically a bullish time for stocks. This is because the economy is usually strong when the Federal Reserve raises interest rates, which provides a lift to corporate earnings and to stocks. It is also because certain sectors of the stock market outperform during times when interest rates are rising. Specially, the financial sector does better than the overall stock market, because financial stocks make more money as interest rate spreads widen during interest rate hikes. The bullish performance of financial stocks often leads the entire stock market higher.

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