Bearish Market Watchers Reverse Course - For Now

The October stock rally has some bearish forecasters masquerading as bulls just in time for Halloween. But a number of these equity strategists say investors should enjoy the treats now and watch out for a tricky market in 2012.

“I think capital markets will be good for the last part of the year, and in the first half of next year we’re in for a pretty big struggle,” predicts Barry Knapp, U.S. Stock Strategist at Barclays Capital. ““The outlook for the first half of 2012 is pretty bleak.”

Knapp currently has a year-end forecast for the S&P 500 of 1260, but he now says that’s probably too low. (The S&P 500 is up 28 points Thursday to about 1270.) He predicts the rally will continue into early December before running out of steam and setting up for a correction in the New Year:

“Generally speaking there’s at least a 10% downside from wherever we end the year,” he says.

Ride the Tide

Strategist Michael Belkin, meanwhile, has reversed course, covering short positions and advising his hedge and mutual fund manager clientele to buy into the rally.

“We are reversing the defensive trades established seven months ago and now look for a bounce into year end,” Belkin writes in a recent note.

He is noted for calling big market turns, including his March 7th Belkin Report, which advised investors to bail out of most long stock index positions and go defensive, if not outright short most stocks while buying bonds. The S&P 500 declined 8.3% from that note until his October 17 call to go long. Read story.

Belkin calls the October rally a “bounce in a downtrend” for both the stock market and the economy. He writes, “The fundamental view of an end to the business cycle hasn’t changed.  We’re just looking for an interlude in which most risk markets have a two- to three-month bounce.”

His model forecast industrials and tech stocks to take off last week and, as of Monday, Belkin expected banks to outperform the S&P 500. The strategist prognosticates the major indexes will “peak late this year or early next year.”

He is also reversing an earlier call by recommending that investors sell or go short US Treasuries and other sovereign debt while buying stocks.

Missing the Move

Individual investors once again have zigged while the market zagged. They pulled a net $10.3 billion out of domestic stock mutual funds in the first half of the month according to data from ICI.And many pros have also missed the move awaiting an October “event” in a month known to be cruel for stocks, notably bringing the crashes of 1929 and 1987.

Belkin says if this so-called sideline money piles back into stocks, that momentum may send markets even higher: “Psychologically, a waltz through October without a crash could provide encouragement to portfolio managers to get back to the serious business of ramping up stock prices through year-end.”

Market participants are understandably gun shy about buying into this uptrend. Headlines out of Europe about the ongoing debt crisis frequently move the major equity indices by 1% or more in a matter of minutes. (Indeed, Thursday's agreement to tackle the Greek debt crisis has the Dow up by 2.5%.)

As one money manager who oversees several billion dollars put it, “It feels like we’re being held captive by how (German Chancellor Angela) Merkel feels in the morning.”

And it’s not just Europe. Investors quip there’s no longer a wall of worry, there’s a world of worry. There’s a congressional “super-committee” trying to solve the homegrown debt crisis that stripped the US of its triple-A credit rating, persistently high unemployment is raising concerns over holiday sales, double-dip recession fears abound, and corporate America’s profit forecasts may disappoint investors.

Stocks have vaulted over these issues since a late summer slide triggered in part by the unprecedented downgrade to the USA’s previously pristine sovereign credit rating.

That event was followed by weeks of volatile trading for stocks. This period featured a slew of disappointing economic data and a number of high-profile calls, including the Economic Research Cycle Institute’s, that the US economy was slipping back into recession.

In a note to clients, BofA Merrill Lynch economist Ethan Harris warns investors to “enjoy it while it lasts”. Harris says the risk of a near-term recession is receding, but the odds of recession next year are rising sharply.

His growth forecasts for this year are higher than the average among Wall Street economists. But he sees growth in 2012 slowing more than most of his peers’ forecasts due to expected tighter fiscal policy.

Barclays’ Knapp says better-than-expected economic data is part of his thesis for an extended autumnal advance for stocks. He also attributes the near-term bullishness to Corporate America’s robust profit reports, the US avoiding recession, and China skirting a sharp economic slowdown.

Knapp is not bullish on a European resolution, rejecting that idea as a catalyst for the recent rally.

“I disagree with that. Not a single customer I’ve spoken with recently believes that Europe can stabilize the crisis, much less solve it.”

Knapp says a deeper debt crisis and acrimonious American politics will derail the stock market’s upward move in 2012. “The upside to capital spending, business confidence and hiring is limited because of election-year politics. And in Europe, they’ll have another wave of this crisis.”

Last Call?

Morgan Stanley strategists have advised clients buy into a “tactical rally” since at least an October 5th note, but that tune is changing.

Gerard Minack, Global Developed Markets Strategist for the firm, cautions, “It may run on a little longer, but it’s not the lop-sided bet it was three weeks ago.”

“We now think the risk-reward in favoring of the rally is reduced,” says Minack, calling it “a bounce to sell into.”

There are wildcards that may extend a stock rally longer than many strategists expect. These include continued better-than-expected economic growth and corporate profit forecasts, a workout for Europe’s debt woes, and further stimulative efforts by central banks including the Federal Reserve.

“With politicians and central bankers around the world driving markets, it’s become virtually impossible to call direction on a short-term basis. So anything can happen in the next few months into year-end that have nothing to do with economic fundamentals,” said one Wall Street strategist who did not want to be named.

He professes an aversion to buying stocks right now but adds, “I’m not a raging bear because money printing can lift asset prices and I want to be in the money-printing trade of precious metals, energy and agriculture.”

Taking Stock of 2012

Pat Becker, Jr., who helps oversee $2.1 billion at Becker Capital Management, says he would not be surprised to see more Fed and government “maneuvers”.

The Portland, Oregon-based money manager also says he looks at the calendar change to 2012 as a friend to the current trend. “In an election year, the incumbent will throw in the kitchen sink to show progress.”

Whether these efforts to juice the economy trick or treat stock investors, Becker remains pragmatically optimistic about equities.

“No one’s willing to predict beyond year end, which is possibly the right thing to do,” he reasons. “You’ve got to feel for next year ‘are we going into recession again or not?’ I don’t think we’re going to double dip, so stocks look inexpensive. We’re in the camp we won’t see another recession so we’ve been buyers of stocks in here selectively.”

The firm this month has been taking profits in defensive names such as Coca-Cola (NYSE:KO) and buying beaten down economically sensitive stocks including FedEx (NYSE:FDX).

But Becker is keeping a watchful eye on yet another area for possible red flags. He’s taking cues not from developed economies such as the US or Europe, but rather from China and emerging markets.

“That’s the real growth driver,” he says. “The (market’s) focus is on Europe, but we see that muddling along; it’s more important to keep a closer eye on the emerging markets, because (a slowdown there) is not priced in.”