The S&P 500 Index marked a historic high Thursday. Even so, macro-driven investors might consider paring down or selling out of their SPDR S&P 500 (NYSEARCA:SPY) stakes here. The record breaking move could mark a kiss of death and begin an overdue reconsideration of stocks. That would obviously have a profound impact on the SPY. Stocks have been rising despite still questionable economic data, no matter what the Fed math indicates (it doesn't add up). Also, the broader indexes and ETFs like the SPY aggregate the performance of corporate components. With earnings estimates clearly coming down for Q1, valuations for stocks are going to prove to be overstated and expectations for their performance left unsatisfied. These are very good reasons to sell the SPY. One sticking point I'm having trouble getting past, though, is the fact that capital flows continue to come fast and furiously into equity funds, and will continue to support stocks as a result.
The market has been ignoring what may very well be the signs of a new recession. If that's the case, you are going to want to short the SPDR S&P 500, because investors must eventually reevaluate whether their stock bets have been well placed. American GDP was just revised upward to 0.4% for Q4 2012, up from the first report of contraction, but short of economists' expectations for 0.6% growth. The ECB just cut its euro-zone GDP forecast, and this latest Cypriot banking issue has raised new concerns about the system. Meanwhile unemployment is increasing across Europe, including in Germany, as reported Thursday. America still sells 20% of its exports into Europe. Obviously, we have continued to grow despite Europe, but the latest consumer confidence drop-off should worry investors about U.S. economic activity. I expect the consumer confidence drop was due to the real impact of the payroll tax break expiration. Manufacturing activity and housing have been growing, but even those two drivers have offered some warning signs of late, including within some regional manufacturing indexes and in Pending and New Home Sales data.
A second very good reason for the market to reconsider stocks is earnings season. According to FactSet (NYSE:FDS) data, earnings estimates for the first quarter, which is ending this month for most companies, have seen extraordinary cuts. Should stocks really get a bid when the estimated earnings growth rate for Q1 is negative 0.6%? FactSet indicated that if the final figure is negative it would mark the second year-over-year decline in earnings in the past three quarters. On December 31st when this rally started to find some real steam, estimates were indicating 2.2% growth. Not one sector has seen upward adjustment, out of the ten reporting downgrades to estimates. The report shows that a great majority of early earnings reports have been warnings, but I suppose that is normal for EPS surprises.
Guess what, if estimates are off, then P/E ratios are overstated as well, so stocks may not be as cheap as many have thought either. Along with the SPY, the SPDR Dow Jones Industrial Average (NYSEARCA:DIA), PowerShares QQQ (NASDAQ:QQQ) and their components might also see some reconsideration.
The SPDR S&P 500 was up 10.5% in the first quarter of 2013 after increasing 16% in the full year 2012, after adjustment for dividends. The S&P 500 Index has a P/E of about 14X now on forward estimates, placing it above its 5-year average of approximately 12.8X and very near the 10-year average of 14.2X. Estimates have continued to face trimming since the March 8 FactSet report, and stocks have continued to rise, because the forward P/E was roughly 13.4X at that time. Thus, it's getting harder to find value, especially in an environment where EPS estimates are declining. I think stocks have to reconsider valuations now, and the SPY should sell off as a result. So I would consider reducing general market exposure and selling the SPY against long positions in alpha value-adding ideas. I would do those things, if not for the fuel stocks are receiving from capital flows into mutual funds. Until that stops, what is there to stop stocks?