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Reversal of Stock Prices Good News

I’m talking about that huge reversal for stock prices that came on Friday.

 

By  Briton Ryle

Well, well. The most bullish event we’ve seen in six weeks occurred at the end of last week.

No, I’m not talking about the latest employment report — that was actually the weakest jobs growth we’ve seen in a while. And I don’t mean the crazy good auto sales numbers from Thursday, though I will get to that one in a minute.

No, the good news we got was of the technical variety. I’m talking about that huge reversal for stock prices that came on Friday. The Dow was down 250 points in the early going after the jobs number came in well below the consensus. It looked like it was going to be another one of “those” Fridays…

But the bottom didn’t fall out. Instead, the buyers stepped in, and the Dow rallied 450 points from those early lows.

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That may have been a very significant move for the stock market. Here’s why…

If you watch the market action on even a semi-regular basis, you’ve certainly noticed that there’s been a tendency for stocks to make strong moves higher in the morning that fade as the trading day progresses. On several occasions over the last six weeks, 200-point morning gains have finished in the single digits or even as losses.

September 17 is a good example. The Dow (NYSEARCA:DIA) opened at 16,738 and rallied merely 200 points to 16,933. But it closed at 16,674, down over 50 points.

Days like that tell you investors and traders do not want to own stocks. They see the upside simply as an opportunity to sell. And there’s been a lot of selling lately.

We’ve reviewed the reasons at length: China’s economy, emerging market (NYSEARCA:EEM) debt, the Fed, falling earnings growth, and so on…

But here’s the thing: The economic news doesn’t necessarily matter; it’s people’s reaction to the economic news that matters. I mean, we’ve gotten plenty of bad news over the last five years — European debt, Greece, fiscal cliffs, and government shutdowns. And while each of these events sparked a little downside, they were not turning points for the bull market. Traders that thought they were and positioned themselves to make money on the downside got creamed.

Yes, the market has shrugged off bad news for a long time. Still, this latest correction, which has dropped the Dow 12% from all-time highs, felt different. For the first time in years, it really felt as though corporate profits might actually shrink…

Vicious and Virtuous Cycles

Corporate profits are the lifeblood of the stock market. When profits are rising, stock prices rise, too.

It’s a pretty simple upside story: People buy stuff when they feel good about the future, and when people buy stuff, corporate profits rise. When profits rise, companies are more likely to give raises to employees and hire new employees — that’s how the virtuous cycle works.

But when corporate profits start to fall, the whole formula falls apart. Corporations stop hiring, and they may freeze wages. Employees respond by tightening the budget and spending less. The corporate profits fall more, and then you get the vicious cycle.

It’s the fear of the vicious cycle that’s got investors feeling jumpy.

If China’s economy falls apart… if emerging economies starting having currency crashes… if the Fed hikes interest rates, making money more expensive… well, it’s pretty easy to see there are some threats to corporate earnings growth out there. And earnings growth hasn’t been all that great anyway…

I’ve talked at length in the past about how stock buybacks are hiding the fact that earnings growth has been on the weak side. Even though earnings per share is now higher than ever, part of the reason is that there are fewer shares out there.

In fact, corporate earnings would show an actual decline this year if it weren’t for buybacks. People know this. Investors know that the whole virtuous cycle thing can end very quickly. And if you ask me, that’s why investors have been so quick to sell lately.

It’s also why Ford’s news from last week is a potential game changer for this stock market.

Thanks, Ford!

For the second month in a row, American auto sales were fantastic. 1.44 million cars were sold in September. That’s up nearly 16% over last year. American auto sales are on pace to hit 18.2 million this year. That would be the best in 10 years.

September was especially good for Ford (NYSE: F). For the second month in a row, Ford narrowly missed selling 70,000 F-Series trucks. How good is that? Total Ford truck sales were up 16% over last year, and retail truck sales were up an incredible 31%.

The distinction between total truck sales and retail truck sales is important. Total sales include fleet sales, which come with lower prices and margins. Ford has been scaling back its fleet sales in order to focus on higher margin retail sales. So when you read that GM is selling more trucks than Ford, yes, it’s true. But Ford is making money.

And what’s more, the 31% gain in retail sales shows that Ford’s aluminum-bodied trucks are being well received. That has potential to be even more significant over the next few years because Ford is the first mover, the innovator, in the aluminum-bodied truck space.

Ford has already idled factories to retool them for aluminum. Ford has already set up the supply chains and trained its workers. It’s way ahead of GM.

Never Underestimate the American Consumer

Auto sales are an important measure of consumer sentiment and economic strength. People don’t buy new cars when they are pessimistic about the future.

So while investors have been increasingly concerned about what’s coming for the U.S. economy, profits, and wages, the American consumer doesn’t seem to be. And that’s more important than what the big money thinks.

In case you are wondering, Ford is trading with a forward P/E of 7. Yeah, it’s cheap. Also, the dividend yield is 4.3%, which is historically high, and there is likely to be a dividend hike this year as the new aluminum truck sales hit their stride.

Right around $14 now, Ford could easily be a $17 to $18 stock by the end of the year.