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I have been growing increasingly pessimistic about the rally being able to continue over the past several weeks. There are myriad concerns for the market and these seem to be increasing even as the market continues to rally. Geopolitically North Korea and Iran are becoming increasingly problematic. The situation in the Middle East (Syria, Egypt, Pakistan, etc...) continues to grow worse. In addition, S&P earnings are only expected to be up less than 2% Y/Y in the first quarter. Corporate insiders are also selling at the highest levels measured since 2004. However my three biggest concerns (Consumer Spending, Job Growth and Europe) remain the same. Deterioration on all three fronts is knocking the market down in early trading Friday. I believe there is still a lot of "buy the dip" mentality among fund managers given most are behind their benchmarks, but eventually this will dissipate as they realize that the same second quarter "hiccup" that derailed the markets in 2011 and 2012 has once again arrived.

Consumer Spending -

One of the main drivers of today's sell-off has been the April University of Michigan consumer confidence survey results released today. The report showed a reading of 72.3 instead of the 79 reading expected and significantly less than 78.6 level reported last month. The confidence level is now at a nine-month low. The reading is surprising given the drop in gasoline prices over the last few weeks. In addition, retail sales fell by .1% in March, much lower than the .4% increase expected. Some analysts have dismissed the negative readings, chalking them up to colder than normal weather in March. However, I believe the bigger reason for the decline is the impact of the payroll tax holiday expiration that took $120B annually out of the economy. An additional $60B in tax hikes probably is not helping this metric either.

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Job Growth -

I still don't feel the market has fully absorbed how lousy the March Jobs report was, partly because the unemployment rate "fell" to 7.6% from 7.7%. This only occurred because 496,000 people dropped out of the work force. This is more than five times the 88,000 jobs created in the month. In addition, the U6 level (measures part-timers looking for full-time positions in addition to unemployed) of unemployment is 13.8%. Yes, weekly job claims dropped 42,000 positions earlier in the week. However, the less volatile four-week average of job claims was up 3,000 to 358,000 last week.

With the oncoming sequester cuts just being rolled out, another headwind to the jobs number will take hold. In addition, the implementation of the Affordable Care Act will continue to be a significant disincentive to hiring in the small business sector for the rest of the year. The housing recovery is a positive factor and should continue to be a positive for construction job growth. However, the substantial slowdown in retail and hospitality job growth that came to light in the last jobs report will probably continue given the poor retail sales and consumer confidence levels out today.

Europe -

The Cyprus situation continues to get worse. Today, it came to light that the island nation is in a $23B jam, not the original $17B figure originally reported. Greece unemployment also just reached 27.2% in the last period measured, which is a record. The whole continent is expected to contract again in 2013. Slovenia's banks are believed to be in trouble and the country could be the next country to come to the "bailout" trough. The one positive for Europe is that the liquidity unleashed by the Japanese Central Bank could help keep interest rates lower than they otherwise would have been. However, neither this development nor anything else that appears to be on the horizon right now will lead the continent to getting back on a growth path anytime in the near future. The continent is likely to provide a variety of landmines for the global equity market for the rest of the year.

So what should an investor do?

  • Get 5% to 15% of your portfolio (depending on risk tolerance) into cash so it is ready to deploy at lower levels in the market.
  • Consider selling just out of the money calls on your positions to pick up premium income and reduce your overall portfolio volatility as well.
  • Make a shopping list of high quality stocks to buy if they were to drop 5% to 10%.
  • Be patient. It is hard to predict when the second quarter "swoon" will actually happen given the current buy the dip tenor of the current market. However, rest assured it will occur if deterioration in these three key watch items (Consumer Spending, Job Growth and Europe) continues.
Source: Second Quarter 'Hiccup' On The Way