Nervous investors took a big bite out of Apple (AAPL) last week. The stock plunged 14% after the company reported its quarterly results and offered tepid forward guidance. The sell-off in the market's second-largest company, however, did not deter the broad advance of stocks as a whole, as the S&P 500 climbed over 1,500 for the first time in five years.
Such market resilience in the face of other troubled bellwethers (let's also toss Intel (INTC) into the mix) suggests that downside risk for the moment is somewhat limited. Apple, incidentally, now looks quite attractive, trading at only eight times cash flow. More important still is the wide base of the rally, which augurs higher prices ahead for all the major market indexes.
One proprietary indicator we track, employing the New York Stock Exchange's weekly advance/decline line to gauge internal market strength, reached a very bullish and seldom-seen level last week. Looking back over the 38-plus years of available data, in the mere 24 instances that similar readings occurred, the S&P 500 generated above-average returns in the subsequent three-, six-, and 12-month periods.
On average, in the six months following readings on par with the one today, stocks have climbed 9.5% (excluding dividends) -- more than double their typical six-month return. Simultaneously, during these periods, the performance of small-cap shares have been even better. That's not to say share prices can't also decline under these conditions. But again, looking six months out, returns have been positive 88% of the time, with the worst drawdown at less than 6%.
This rally has occurred not only because Washington removed (or at least postponed) some uncertainty with respect to the debt ceiling and fiscal cliff; stocks are also responding favorably to a smattering of economic indications of acceleration. For instance, durable goods orders for December were released, with the headline number coming in at double what analysts had expected. It seems as if despite the fiscal cliff worries, corporate spending continued to ramp up last month.
We'll learn more about the hiring side of the equation upon release of the next employment report on Friday. We're encouraged, however, since initial claims for unemployment insurance have been inching down and stand at their lowest level since the start of the last recession five years ago. Of course, while a stronger economy would be welcome news and a catalyst for improved corporate earnings, it also carries potential problems -- namely, steeper commodity prices. And as we've seen in recent years, higher commodity prices can short-circuit even the most robust expansions.
We're still a long way from that trigger just yet, but consider that Brent crude oil (or West Texas Intermediate, for that matter) has remained persistently high over the past year, despite slow demand growth worldwide. Should demand bounce higher, we could face $150 a barrel oil in short order. And such commodity inflation would not end there. Indeed, the CRB's Raw Industrial Commodity Index, comprised of the basic building blocks of the economy, has climbed nearly 10% in the last quarter alone, thanks to stronger demand.
While higher commodity prices bear watching, for now we'll focus on buying quality stocks with strong franchises, excellent earnings prospects, and reasonable valuations -- i.e., shares with the potential to outperform and generate excellent returns going forward, come what may economically. Nor are these shares limited to the U.S.