The market continues to rally despite a poor jobs report Friday and noises coming from some Fed members that they are growing increasingly wary about the long-term monetary impacts of their current policies. I would love to be more positive on this rally as it has been great for my brokerage account balance. However I am getting more and more skeptical that this rally will survive the second quarter of the year, despite today's surge. It seems every pundit on CNBC is long and positive on the market until asked what would happen if the Fed ceased or even hinted that QE efforts would be curtailed, and where the common answer seems to be the Dow would lose 2,000 points or so. Here are my four main concerns about the market in the second quarter.
With all the talk the continent has stabilized since the head of the ECB Draghi's statement that he would do "whatever it takes" to maintain the Euro, things are getting worse on the continent, not better. The entire Eurozone is expected to contract again in 2013. Some of Portugal's austerity programs were thrown out by its main court recently and the country is scrambling to find another 1B € in spending cuts to meet the terms for its latest bailout tranche. Unemployment is almost 18% and rising from under 12% when the country first needed its bailout package in the second quarter of 2011. Slovenia is now the next domino in the continuing bailout dance in Europe after Cyprus's recent debacle. Twice the size of Cyprus in terms of GDP, 14% of loans in Slovenia's ailing banking sector were non-performing at the end of 2012. At large, state-controlled banks, the figure is 30% (see chart). Don't be surprised if Slovenia comes to the bailout at some time in second quarter, which could provide the next European disruption to our markets.
Worldwide stock Indexes are turning over -
The rally here is not happening anywhere else in the world except in Japan which has joined our Federal Reserve in QE efforts (or money printing depending on your perspective). As a consequence these are the only two markets that are up over the last month. Russia, India, Brazil, China and Europe are all down (see chart).
In addition, the rally has been very defensive. Sectors that one would expect to participate in any sort of "risk on" sentiment like Technology have vastly underperform safe, defensive sectors like Consumer Staples despite the latter having much higher valuations and poorer growth prospects (see chart).
The Jobs Market -
I will not go into too much detail about the dismal March jobs report or deceleration of job growth as I have covered this in a recent article. The two numbers investors should be aware of are 5 and 3. There were five people who dropped out of the workforce for every job created in the March Jobs Report. In addition, even after four years of recovery, there are three job seekers for every job opening. Neither figure bodes well for a robust job recovery that one would expect at this point in the economic rebound.
At the start of the year, analysts expected earnings growth of 4.3% for the S&P in the first quarter. They now expect 1.6% earnings growth. I expect the S&P to beat these reduced earnings figures that have been taken down in a quarterly ritual I call "The Analyst Two Step." However, earnings growth of less than 4% hardly seems worthy of the ten percent rise across our indexes since the beginning of the year given the current macro environment.
Color me skeptical, but with the exception of the Fed and the housing rebound its policies are enabling, I see little to be very positive about in the market given its robust rise in the indexes since the post-election sell-off. An investor has to continue to dance while the Fed is playing DJ, but keeping 10% to 20% of one's portfolio in cash awaiting lower entry points seems prudent here after the large rally of the last five months.