Even the Bears Should Be Bullish Now

Right off the bat, I want to say I am a bear over the long run. Our reckless fiscal and monetary policies, the collapse of housing and an underappreciated jobs crisis will weigh on the U.S. economy like a wet blanket far into the future. Home prices remain in freefall and foreclosures are still exploding higher.

But none of that means the stock market can't go up now. People too often confuse the economy with the market, when in reality the two interact in a push-pull process that resembles a company of Marine Corps recruits on a forced high-speed march. Some 400 young men weighed down with packs and weapons struggle to keep up with each other as they traverse woods, sandy ground and smooth roads. They're in varying degrees of physical fitness and are constantly harassed by drill instructors ordering them to yell and sing. Sometimes the front moves far ahead and recruits towards the rear must run to catch up. Other times the leaders slow down and are nearly trampled by the ranks hurrying behind to keep up.

Think of the stock market as the front end of the column. It had slowed down after hitting a patch of sandy ground, causing the entire formation to pile up. But now the leaders have moved onto a smooth road and are charging ahead while everyone lingers behind.

The S&P 500 fell into the sand trap in October and the economy quickly followed. Equities returned to smooth ground in March, and now the economy is trying to do the same. Whether or not it succeeds is irrelevant for the time being. Equities are breaking free of those concerns and can rise despite more bad news on housing, earnings or oil inventories. Only after stocks and commodities have rallied further will people begin taking those concerns seriously again.

There are several reasons why even the bears should be bullish now.

The technical picture couldn't be stronger. The S&P 500 has been doing everything right and bounced off the 890s area on May 21 and May 26. That level was not only the 30-day moving average. It was also just above old highs that had kept the market in check during April. In other words, resistance is now support - which is very bullish. With buyers putting the floor in, the index is being forced higher.

The next big hurdle is the 200-day moving average, looming overhead like a ton of bricks. The last time we challenged it on May 19, 2008 turned into a debacle and was followed a 53 percent drop over the subsequent 10 months. But this time, we've paid our dues and carry the battle scars as proof. The chart reflects this strength: Instead of impetuously charging towards the 200-day moving average, the S&P 500 has trended down from its peak in early May, following a resistance line that ran parallel to the 200-day moving average. We broke that resistance line Friday on heavy volume and the 200-day moving average is next. More than $3.75 trillion of cash remains on the sidelines in money-market accounts. Once we break through the 200-day moving average, that money will stream back in to stocks.

Next, a little inter-market analysis: I believe that certain charts interact and can serve as leaders for the broader stock market. This has recently been the case with both the euro/dollar cross and oil. As a broad measure of risk appetite, euro/dollar has been rolling out the red carpet to the stock market. When it reaches key resistance levels, stock investors should watch out. But when it breaks free and has nowhere to go but up, the wheels are greased for an upward-trending stock market. (I discussed this in an earlier column using euro/yen).

Fortunately for the bulls, euro/dollar remains in a powerful ascent:

The Euro as of 5/29

I won't bother with the oil chart, but it's similar to euro/dollar. Both made higher lows in March when the stock market made a final new low. They are clearly the leaders right now and should be followed.

The credit market has also shown obvious improvement. Borrowing costs have fallen 2-5 percentage points and issuance is exploding higher. Some observers make a big deal out of financials like Bank of America and Citigroup selling debt that isn't insured by the government. It's a nice footnote, but the more important fact is that banks are declining in relevance and being replaced by real companies again in the credit market. Financials, often working through off-balance sheet surrogates, dominated the bond market in an unprecedented way during the credit bubble, accounting for 64 percent of issuance in 2006 versus 46 percent in the 1990s. Non-financials like Pfizer are now leading bond issuance again, which marks a return to some kind of normalcy.

Another positive is that banks have already finished a lot of the balance-sheet repair that needs to happen. Using the Fed's H.8 report, I developed a bank risk indicator. (It's the amount of loans and non-government bonds banks hold as a percentage of total credit, minus government and agency bonds as a percentage of total credit.)

This index shot up to extremely high levels last year as the financial crisis forced banks to take assets onto their balance sheets. Since then, they have undone that damage, plus all the froth dating back to 2005. This indicator will continue to work lower, but the most jarring pain is behind us. We now face a period like the early 1990s, when the banks steadily improved their balance sheets and laid the groundwork for a great economy, plus bubbles in the equity and credit markets.

There are still many reasons why the current period differs sharply from the 1990s, and we're not looking toward any kind of bull market like that again. The troubling differences between then and now will be the subject of a future column.

But, now is not the time to worry about what might go wrong. There will be a time when the current jubilation ends. When it does, everyone will talk about how excessive it was and how people ignored the risks. But that could be far into the future. For now, too many positive signs are lining up to be anything other than bullish.