I’ve been accused by some of my less than bullish buddies of being a bit too optimistic in my writing of late. To be honest, I guess I am guilty as charged on this score.

What I have been attempting to do lately is to change the narrative from the usual prognostications about what is going to happen in the stock market in the next 5 minutes to what is likely to happen over the next year. You see, from my perspective, the short-term machinations of the S&P 500 have become nothing more than computer generated noise. And unless you have the capital and the capacity to trade on a millisecond basis, I’m of the mind that investors have to forego the near-term action – which is clearly dominated by computer-driven algo trading – and focus on the bigger picture.

So as I’ve been saying, once we get past the weak seasonal period that is upon us (and starts in earnest next week), the bottom line from a longer-term perspective is I find it difficult to be negative on stocks. Sure, there are issues – there always are. And yes, stocks could drop 5% – 10% for any reason, at any time. However, when looking at the big-picture drivers of stock prices, my models tell me to side with the bulls.

Trying To Stay Open Minded

However, I have found over the years that taking a look at the situation from the other team’s perspective can be a very good exercise. Thus, I’d like to spend the rest of my time this morning taking a look at what could go wrong with the bullish case.

There is little doubt that traders are focused on interest rates, the Fed, and the U.S. dollar at the present time. And for good reason. As I see it, the biggest problem the bulls might encounter in the coming months has to do with these issues – or at least two of the three.

Frankly, I don’t think investors need to worry much about the Fed getting ahead of themselves and damaging the economy. If Bernanke/Yellen had even an inkling of doing so, the FOMC would have started raising rates years ago. No, Yellen & Company have made it clear that they are going to continue to err on the side of caution as they’ve worked too hard for too long to let things go south here.

But it is important to remember that the Fed only controls short-term interest rates – as in the Fed Funds rates – and that Ms. Market controls the rest. And THIS is where things could get sticky.

The Worry

To be sure, the bears have been calling for a calamity in the bond market for many years now. So far at least, this has been a case of the boy who cried wolf. And if I’m being honest about the subject, I for one, can’t argue with the “lower for longer” case on interest rates.

However… let’s also recognize that Wall Street tends to overdo things. I.E. once a “trade” becomes popular, it tends to be overdone until it becomes a problem. And in my humble opinion, this is most certainly the case when looking at the low volatility/high dividend space these days.

According to Ned Davis Research, the valuation levels in the low vol/high div stocks are at record levels – and at levels seen during some pretty brutal times in the past. Heck, even the level headed analysts at NDR are using the word “bubble” to describe the situation. Thus, if this “trade” begins to mean revert, the selling would likely spill over into the rest of the market. And while this isn’t really a systemic risk situation as we saw in 2008, a mean reversion move in low vol/high div stocks could certainly create a meaningful decline in the overall stocks market that could also last a while.

What would cause investors to suddenly flee the consumer staples, utilities, telecoms and real estate sectors (which, when combined account for about 20% of the S&P 500 weighting at this time), you ask? That’s simple. Higher rates.

The question then becomes, what would create a meaningful, long-lasting surge in interest rates? Personally, the most logical cause of such a problem would be a significant improvement in the economic data – around the world.

Yes, a stronger economy here in the U.S. would certainly put “some” pressure on rates. However, I’m talking about a BIG problem here – such as a move on the 10-year above 3%. And from my seat, it would take the economies of the world perking up significantly for traders to flee their beloved high dividend payers en masse.

The really big problem in this scenario is that we could easily wind up in a world where the prices of stocks and bonds would fall at the same time. And since (a) this isn’t supposed to happen and (b) the robos and computer models that drive so much of the world’s investing capital these days aren’t likely prepared for such a scenario, well, this could become an issue.

The Bottom Line

Before you run out and start buying those inverse ETFs on stocks and bonds (symbols SDS and TBT come to mind), you should understand that (a) I’m talking about a significant move in rates and (b) the nightmare scenario described herein isn’t even close to coming to fruition. In fact, the ECB, the BoE, and the BoJ are all still printing money to try and generate some “inflation” (which is really fedspeak for economic improvement). And with the Chinese also looking to stimulate activity, we are likely a long way from a world that is overheating from an economic standpoint.

So, with the yield on the U.S. 10-year trading under 1.6% this morning, the bond market would appear to be saying that we shouldn’t get too concerned about the Nightmare on Wall Street our friends in fur continue to fret about.

At the same time though, I think it is important to try and understand what “could” be the next big problem for advisors and investors alike. As such, my plan is to continue to monitor our key models on a daily/weekly/monthly basis and remain flexible/open minded with regard to what is actually happening (and why) in Ms. Market’s game.

And from my point of view, this means that investors should remain positive on stocks and stand ready to buy the dips. But there I go again…

Current Market Drivers

We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).

    1. The State of Global Central Bank Policies

    2. The State of U.S. Economic Growth

    3. The State of the U.S. Dollar

Thought For The Day:

It is not true that nice guys finish last. Nice guys are winners before the game even starts. -Addison Walker