Market’s ultimate upside could prove legendary

Not even half way into the second quarter, the Dow Jones Industrial Average has exceeded my year-end forecast if 15,100. The natural inclination may be to cite this as evidence of a market that has run fast and furious to perilously extended levels.
My technical appraisal at this juncture, however, presents a more constructive interpretation of the price propulsion that has driven the major stock averages to uncharted heights. Indeed, the technical atmospherics are at odds with human emotions that evoke cries of “Overbought!” While I must logically concede that a pullback is due and could occur at any time, given the market’s run year to date, the price architectures, net money flow trends and impressive depth of attractive individual stocks representing the market’s leadership provide a cumulative strong case for higher stock market levels – not just longer term, but shorter term as well.
I have been steadfast in my position that this bull market cycle was spawned nearly 11 years ago. The 2002 market bottom packed powerful technical credentials that I believe could make the market’s ultimate upside potential in this cycle legendary. Here are four reasons why:
1) Price architecture depicts an orderly advance.
While some market observers anxiously await correction, a consolidation of sorts has been underway for weeks. It has subtly unfolded as a series of rotational pullbacks among the market’s core industry categories. This self-policing of price and sentiment excesses has continually characterized the prevailing cycle. These exercises have preserved healthy chart patterns with backing and filling movements that have established incrementally higher support levels as stocks advanced. This, in turn, has served to maintain an attractive risk/reward ratio for the overall market.
So far in 2013, the DJIA has had several episodes of sharp, daily declines, which have repeatedly proven to be short-lived events. The market’s resiliency in the immediate aftermath of these triple-digit declines underscores the durability provided by bullish cup-and-handle patterns that have been manifest in many leadership stocks for years. I believe the full upside potential of these historically bullish formations has yet to bloom.
2) Broad and diverse sector leadership has prevailed in this cycle.
Unlike in the previous two cycles, this cycle has yet to lapse into concentrated buying activity in a particular sector, or a thematic-focused handful of sectors. As a result, the market has withstood a series of adverse micro-thematic events. In addition, speculation has been mostly absent from this advance and there has been little multiple expansion based on heightened confidence and more aggressive buying.
Noteworthy also is the market’s elasticity and its ability to navigate successfully through challenging headline news since 2009, which can be mostly attributable to the liquidity-driven broad swath of industry leadership. The broad sector leadership in this cycle is one of the most stunning internal factors of this advance I have observed and has contributed significantly to the market’s foundation. The formidable technical support upon which this market cycle has been built appears capable of launching stock prices to substantially higher levels before the cycle’s conclusion. (I revised my DJIA target to 18,000 in January.)
3) The Fed is transparent.
Granted, interest rates are hovering near historically low levels. But, in my opinion, the principal takeaway from the Fed is its deliberate transparent policy, which has provided an investment environment virtually free of angst over monetary uncertainties. The central bank has virtually assured the financial markets that it will provide fair warning before ratcheting rates higher. I do not recall such a setting at any time in the last 40 years. With monetary uncertainty reduced dramatically, investors are able to focus on earnings quality with greater confidence and reliability.
Indeed, earnings are reflecting the benefits of the Fed’s Quantitative Easing efforts and that, in my opinion, provides a clearing for higher stock levels. The equity market’s consistently positive course seems to indicate glad tidings for the economy’s growth prospects.
4) There remains a distinct disconnect between a rising stock market since March 2009 and the public’s cautious view of growth stocks.
The advance to date has been stealth, with the rising bull market only recently making financial headlines. Crossing millennium levels in the DJIA has not been trumpeted and long-term skeptics have remained unimpressed. But, psychology has begun to shift and this could spur accelerated moves to higher ground.
Ultimately, I think there is good reason to expect that this cycle will end in a manner similar to those of the previous two cycles. That is, I expect today’s tepid interest in stocks among sidelined investors to be transformed into excitement and urgency as major corrections remain elusive and economic data improves. There is technical sizzle underlying this bull market and I continue to expect higher levels before a major decline of 10% or greater unfolds.

(Eugene E. Peroni Jr. is an SVP and portfolio manager at Advisors Asset Management)