On October 4, the major stock indexes narrowly escaped entering bear market territory.
Heck, if it weren’t for a rebound in the final hour, we would have dipped below the defining bear market threshold – 20% lower than the high set on April 29.
But this Monday, stocks advanced 3%, capping off an 11% rebound in just one week.
So what’s it going to be? Is a nasty correction looming on the horizon? Or is the stock market gearing up for a triumphant year-end rally?
Although it might not be the popular stance, I’m convinced there’s enough evidence to support the latter. And over the next two days I’m going to share the overwhelming proof.
So let’s get to it…
The Contrarian Side to Sentiment
As longtime readers know, I’m a diehard contrarian. And the reason is very straightforward.
Time and again, I’ve witnessed Humphrey B. Neill’s observation – “When everybody thinks alike, everyone is likely wrong” – prove accurate. And I don’t like being wrong (read: unprofitable).
And the fact that everyone’s thinking alike again, based on the following metrics, is a clear signal that stocks could defy the odds and rally into the year-end.
Reason #1: Lopsided Analyst Expectations. The typical Wall Street analyst isn’t banking on a profit bonanza in the third quarter. To the contrary, he’s trimming expectations at the fastest rate since 2009.
With that in mind, a research report from McKinsey & Co. found that analysts are “prone to making increasingly inaccurate forecasts when economic growth declined.” And in 2011, GDP growth has done precisely that. In the fourth quarter of 2010, GDP growth checked-in at 3.1%. Yet, in the most recent quarter, GDP growth fell to 1.3%.
If analysts are wrong again, expect earnings growth to trump the forecasts, which should propel share prices higher.
Reason #2: Plummeting Consumer Confidence. When U.S. consumers get the gloomiest, stocks typically rally.
Specifically, research out of Ned Davis shows that when the Conference Board’s Consumer Confidence Index is below 66, the Dow rallies by an average of 13.1% over the next year. And guess what? The latest reading in September checked in at 45.4.
Reason #3: Financial Newsletters. Even humble newsletter editors aren’t immune to herd thinking. And right now they’re universally bearish. Case in point: The average recommended stock exposure among a set of market timers tracked by Hulbert Financial Digest stands at -16.8%.
That’s the lowest reading since March 2009. Since newsletter pessimism peaked right as the market bottomed the last time around, history is all but assured to repeat itself.
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Nobody Knows Better Than This Group
I’m sure some of you are reluctant to base your investment decisions on the uninformed opinions of analysts, consumers and newsletter editors. But don’t be. Especially since the latest actions out of corporate insiders – the most informed group – are clearly signaling that it’s time to buy stocks.
Reason #4: Insider Buying. Insiders sell shares for a host of reasons. But they only buy shares for one – to make money. And they’re practically salivating over the opportunities right now.
“We’re seeing the most aggressive insider buying since March 2009,” says Ben Silverman of Insiderscore.com, which tracks insider trading.
Should we behave any differently?
Reason #5: Buyback Bonanza. Insiders aren’t only looking to bank personal profits. They’re also looking to capitalize on undervalued shares to boost corporate profitability. How so? By stepping up stock repurchase programs.
In the second quarter alone, stock buybacks increased 47% year-over-year to top $100 billion. And that’s the eighth consecutive quarterly increase.
More recently, in August, companies announced the most buybacks since February 2008, according to Traders Magazine . And research clearly demonstrates the impact of such optimism on the part of corporations.
A study out of the University of Illinois at Urbana-Champaign shows that companies buying back their own shares typically outperform the broad market over the next four years, by as much as 45%.
Heck, Warren Buffett’s Berkshire Hathaway (NYSE: BRK-A) even instituted a repurchase program in the past month.
Mind you, it’s the first one Berkshire has announced in four decades. So Mr. Buffett obviously believes stocks are cheap, too.
Are you willing to bet against his track record? Me either.
Bottom line: The lopsided sentiment of consumers, analysts and newsletter editors suggests it’s time to do the opposite of the herd… and buy stocks. The actions of the most informed group of investors – corporate insiders – only adds to my conviction.
If you’re still not convinced, though, stay tuned. Tomorrow I’ll share another five reasons stocks are headed for a year-end rally.
Ahead of the tape,