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Bulls Get It Done Again

This time, they ignore higher oil and bid up stocks on earnings and economic data.
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Bulls are proving to be not only resilient but also resourceful. For a second day Tuesday, the market shrugged off rising oil prices to seize on positive factors such as upbeat earnings and bullish economic data.

As the summer-long rally continued, the

Dow Jones Industrial Average


finished up 60.59 points, or 0.57%, at 10,683.74, while the

S&P 500


gained 8.77 points, or 0.71%, to 1244.12. The

Nasdaq Composite


rose 22.77 points, or 1.04%, to 2218.15.

Better-than-expected earnings from the likes of





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fed the profit bonanza, while strong personal spending and income data satisfied the fundamental crowd.

Crude oil rose 32 cents to a new record high close of $61.89 per barrel, after touching an all-time intraday high of $62.30 on Monday.

Both the S&P 500 and the Nasdaq Composite managed to rise Monday despite the new high in crude oil. Bouncing on negatives seems to be a continuation of the trend seen since the London bombings four weeks ago, which led to a huge dip in futures before inspiring a strong rebound that's still in effect to this day.

But the market is also bouncing on positive earnings and economic indications, which seemingly promise a similarly upbeat outlook for profits and stock prices down the line.

Of course, it may be that investors are once again choosing to look at the glass half-full. According to Morgan Stanley market strategist Henry McVey, investor sentiment is reaching extremely bullish territory, a sign for contrarian investors that the downside is not far off.

This after the S&P 500 had its strongest performance for any July since 1997. That doesn't bode well for August. Over the past 15 years, July was a strong month only five times and, of these, only two were followed by a strong August, McVey notes. While history never repeats itself, it often rhymes, as Mark Twain liked to say.

The short-term positive that McVey sees is that the current rally is not being driven by valuation, but by earnings, which by and large have been better than expected for the second-quarter.

"This distinction is important, as we found that earnings-driven rallies typically rise and fall based on the health of the economy, not long-term rates," McVey says.

That would explain the current behavior of the market, which has indeed received an impressive series of economic reports. The strong economy has scared the bond market into expecting (or finally realizing) that the


will lift short-term rates to at least 4% by year-end, with upside risks for further rate hikes in 2006.

On Tuesday, the benchmark 10-year Treasury bond fell 5/32 while its yield rose to 4.33%, after news that personal spending rose 0.8% in June, while personal income increased 0.5%. The core personal consumption expenditures index is up 1.9% on a year-over-year basis, due to revisions of previous income data going back to 2002. That's near the top of the 1%-2% range the Fed favors.

But with investors focusing on earnings, and the economy trotting along, why sweat the Fed? Especially because, according to McVey, "earnings-driven bull markets tend to last 1.5 times as long as

valuation-driven rallies."

Earnings Spin Season

This is where Merrill Lynch strategist Richard Bernstein comes in and pays homage to the skill of CFOs and investor relations managers of S&P 500 companies. Everybody is cheering the second-quarter earnings season because a large number of companies have managed to beat earnings estimates, and make analysts revise their outlooks upward. Never mind that overall earnings growth is slowing.

"What appears to be happening is that companies are increasingly guiding analysts to an earnings figure that the companies comfortably feel can be surpassed," Bernstein says in a research note.

Indeed, "the increase in positive earnings surprises is not really so much of a bullish cyclical environment as it is the result of a secular trend by companies to put a positive spin on every earnings announcement."

The fact is that S&P 500 earnings growth has slowed from 63% in the second quarter of last year to about 11% so far this quarter. And yet, positive surprises have increased and negative surprises fallen during the past four quarters.

The really bad news, Bernstein says, is that there have been only four quarters over the past 14 years that have demonstrated such earnings bullishness in the face of deteriorating fundamentals. These were the first and second quarters of 1998, which preceded the collapse of hedge fund LTCM and the Russian debt crisis; the second quarter of 2000, and the first quarter of 2001, both near the end of the tech bubble.

Trying to sift through which companies to avoid based on these observations may be tricky, Bernstein warns, as some companies' earnings-growth rates may be improving quarter to quarter even if they're down year on year. For instance, some companies' earnings deceleration in the second quarter may not be as bad as it was in the first, he says.

The list of companies that have posted positive earnings surprises while their earnings growth is slowing represents 11% of S&P 500 companies that have reported (60% of all S&P 500 have posted earnings so far). The vast majority of that 11% are cyclicals.

They include such big names as

Electronic Arts



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To view Gregg Greenberg's video take on today's market, click here


In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;

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