Reasons to Be Bullish as the Market Consolidates

U.S. stock markets consolidated their recent gains over the past week, with the Dow Jones down 0.48%, the S&P 500 falling 0.17% and the NASDAQ tumbling 0.06%. The MCSI Emerging Markets Index also fell 2.51%.

Big gainers in your Alpha Investor Letter portfolio included Market Vectors Biotech ETF (BBH), which climbed 4.80%, Illumina Inc. (ILMN), which added 4.20%, and Apple Inc. (AAPL), which gained 1.98%. Market Vectors Biotech ETF (BBH) moved above its 50-day moving average to become a BUY.

Two positions — the WisdomTree Japan Hedged Equity ETF (DXJ) and the iShares Currency Hedged MSCI Germany (HEWG) — moved to a HOLD.

Despite the markets’ recent gains, small investors aren’t buying into the rally. In fact, the widely followed AAII investment sentiment indicator dropped seven points over the past week. That is highly unusual, especially because since mid-February, many measures of manufacturing improved and the prospects of recession faded.

Odds are that you, too, are worried about the state of the markets.

So here are three reasons for my (contrarian) bullish take, with a tip of the hat to analyst Thomas Lee.

First, sales and earnings in U.S. stocks should recover in the months ahead, as the negative effect of the strong dollar on corporate earnings wanes. According to Lee, the U.S. dollar’s 10% jump last year subtracted about $93 billion, or $10 a share, from S&P 500 company earnings. As the drag of dollar strength fades, it will become apparent that the S&P 500 isn’t as expensive as it seems, and stocks should power higher.

Second, the collapse of oil prices has caused great consternation in the markets in 2016. A meeting between OPEC and non-OPEC members could produce an agreement on output cuts, although tension between Saudi Arabia and Iran could derail this effort. Stabilizing oil prices should help energy stocks recover, which have been a big drag on S&P 500 earnings as well.

Third, the current high levels of short interest in U.S. stocks are a contrarian indicator. Today’s level of short interest — a whopping 4.3% of float — exceeds even the levels seen in March 2009 when U.S stocks last bottomed. And a reduction in short interest can have a huge impact on prices. From March 2009 to September 2009, short interest fell by 0.90% and equities rose 50% in those six months.

All these are reasons to think the S&P 500 could break out to higher levels in the coming months. Whether this will happen remains to be seen, but the outlook isn’t nearly as bad as it was just two months ago.

Portfolio Update             

Berkshire Hathaway (BRK-B) dipped 0.49% over the previous trading week. UBS initiated coverage on BRK-B last week with a “Buy” rating. The financial services firm also made a statement regarding a corporate future sans Buffett saying, “While Buffett’s superior capital allocation skills and market ‘clout’ would be missed, as long as the culture does not change, we would expect the company to continue to outperform.” Of course, Mr. Buffett has no public plan to leave his company anytime soon. BRK-B is well above its 50-day moving average (MA) and is a BUY.

Vanguard Russell 2000 Index ETF (VTWO) dipped 1.19%. Although small caps have continued to underperform expectations, this exchange-traded fund (ETF) participated in the recent March bull market run. VTWO is up nearly 13% since bottoming one month ago. VTWO is a BUY.

Google Inc. (GOOGL) gave back 0.96%. Google received a patent yesterday for the use of drones as delivery units for medical devices. The patent implied a scenario where a drone would deliver an automated external defibrillator (AED) to a patient in need. This would eliminate the need for buildings or homes to keep AED’s locally at-the-ready. Imagine dialing up an AED for a heart-attack victim and having it magically appear at the front doorstep, ready to save a life, just minutes later. GOOGL is a BUY.

The Walt Disney Company (DIS) lost 1.18% over the past five trading days. A portion of Disney’s mild weakness over the last week stems from the departure announcement of Tom Staggs, Disney’s chief operating officer. Despite this news, Disney remains a good buy and has been trading sideways for the past eight weeks, consolidating and remaining above its 50-day MA. As well, financial services company Nomura has a “Buy” rating set on DIS and $110 price target — a potential 13.4% move higher from yesterday’s close. DIS is a BUY.

Market Vectors Biotech ETF (BBH) climbed 4.80%. Although markets, as well as many positions in the portfolio, ended the week quite flat, BBH rose all week, jumping on Monday and Tuesday. BBH has been in consolidation mode, trading sideways since mid-February. This pattern makes last week’s pop even more indicative of a bullish future. BBH also moved above the 50-day MA on four days of strong volumes last week to become a BUY.

Costco Wholesale Corporation (COST) gained 0.47%. COST had a big week in regard to analysts’ actions. Oppenheimer recently maintained an “Outperform” rating and raised its price target to $175 — a potential jump of 12.19% from yesterday’s close. Barclays maintained its “Equal-weight” rating for Costco and raised its price target to $180 — a potential 15.39% jump from yesterday’s close. COST is a BUY.

Sincerely,