Stocks opened lower in soft trading Monday, against the backdrop of a relatively quiet earnings calendar and no major economic releases. Stocks moved higher on Friday. The NASDAQ and S&P 500 have recorded six weeks in the 'win' column, while the NYSE couldn't overcome the hole it dug earlier in the week. In spite of their continual winning ways, volume fell across all indexes. Volume is used to help determine the reliability of trend; higher volume drives stocks higher and lower or weakening volume can send stocks lower. At the very least, low volume can foreshadow trend reversals. In other words, think of high volume on an up day as acceleration, and low volume on an up day as the potential beginning of deceleration. At this juncture, market-watchers are divided on whether the market is near a ceiling, or just building a new floor. If the recent uptrend is to continue, big gains in volume will be necessary.
Another critical and necessary element is earnings. Since the beginning of 2012, the S&P 500 is up 20.3%. Problem is, earnings did not grow nearly as fast over that period; that makes us nervous. Since making its low at 676 in March 2009, the S&P 500 has risen 123% to the current 1,512 level. In the same period, earnings reached a low of $49.49 and look to finish 2012 around $101. That represents a gain in earnings per share, of approximately 100%. By measure, S&P 500 earnings - unlike stocks - have not risen 20% since the beginning of 2012. Our primary analyst, Argus Research, modeled 2012 S&P 500 earnings from continuing operations and concluded that earnings during 2012 will likely show a meager 4.6% growth rate from 2011 S&P earnings of $96.75, to 2012 earnings of (an estimated) $101.25. This is particularly worrisome for equity bulls, since strong earnings are required to push stock prices ever higher. Earnings are holding up reasonably well year to date, but things could quickly change, should earnings flatten or decline.
For 2013, however, growth in S&P 500 earnings from continuing operations is projected at 9.6%, or $111.00 per share. A near double-digit rate of return in the current year would put earnings growth in line with the rate at which markets have climbed since 2009. Why are we assuming acceleration in earnings, given that the first green shoots in this recovery were spotted ages ago in late 2009? Shouldn't we be assuming the economy will be decelerating this late in the game, not accelerating? Basically, signs in the global economy are improving and providing some encouragement. Important overseas markets, including Europe and China, are showing better fundamentals. In the U.S., we also see clear signs of acceleration as 2013 picks up steam.
Indeed, the markets are clearly in a confirmed uptrend and the current rally seems to have legs for the next move higher. However, the S&P 500 has started to churn as investors battle for direction, near all-time highs, evidenced by alternating green and red days with volatility and deteriorating volume. In addition to the lack of increasing volume on up days, earnings have failed to keep pace with stock price growth. This kind of choppiness is often foretelling that a rally is getting somewhat long in the tooth.
On the positive side, the 20-day, 50-day and 200-day moving averages continue to trend upward in parallel - a significant indicator of the market's sustained momentum. The relative strength index (RSI) is hovering around 62, which is still considered largely neutral, despite the recent rally. Nonetheless, Bollinger Bands have narrowed considerably, implying that the market is contemplating its next move. In stark contrast, moving average convergence-divergence (MACD) lines have crossed downward through the signal line in possible overbought territory; confirming this notion is slow stochastic oscillators. Rounding out the bearish technicals, the S&P 500 is 7% above the 200-day simple moving average - this has been a turning point for stocks over the last year.
The equity markets have delivered an impressive performance over the last 15 months, but that doesn't mean we should ignore the rising risk of a correction. In the case of a short-term retracement, we remain cautious on further upside, as volume, earnings and investor sentiment are potentially signaling a reversal in the current trend. However, we view 1,450 on the S&P 500 as first support and a solid backstop. We view this as a time to protect profits of highly appreciated stocks and remove those which show weakness. During these times of overbought conditions and investor complacency, we encourage keeping some cash on the sidelines until signs of stability are revealed.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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