Every week I look at four indicators to determine if the S&P 500 (SPY) has enough support to continue its rally or if it will fall prey to another summer slump. The four indicators are: jobs, Federal Reserve policy, Europe and S&P 500 earnings. Last summer these four were the culprits for the S&P 500's correction. This week, earnings season began and Q1 results are becoming the key catalysts for the market's next move. In this article I look at the performance of the S&P 500 and examine each indicator.
Although the S&P 500 continues to move up and its multiple is expanding, I remain cautiously bullish.
S&P 500 Performance
The S&P 500 has been in a strong uptrend all year. Following the disappointing jobs report last Friday, the S&P 500 traded down to its trendline But it rallied back, though ended the week on a bit of a down note.
We are not (yet) seeing a repeat of last summer's price action when the S&P 500 broke its trendline as Q1 earnings season began. I remain bullish, especially with the trendline from the Q1 rally still providing support.
The bullish explanation of the recent price action is that the S&P 500 has pulled back a few times since the November lows, but each time the dip buyers came in to provide more fuel for the rally. The weak price action in the first few days of April was just a temporary pause during a period of no news and the S&P 500 is now continuing to move up on the back of earnings.
The bears would say that no trend lasts forever. Although the S&P 500 bounced off the trendline support, we are due for a longer pause or a correction. The S&P 500 is very extended above its moving averages, especially the 200 day moving average, and it will need to pull back. Furthermore, seasonality suggests a pullback is in order soon. Remember, "sell in May and go away."
Summer Slump Indicators
Here is my overview of the indicators discussed below. If a box is left blank that means that there was not enough "new news" about it.
On Thursday the weekly unemployment claims data was released:
"In the week ending April 6, the advance figure for seasonally adjusted initial claims was 346,000, a decrease of 42,000 from the previous week's revised figure of 388,000. The 4-week moving average was 358,000, an increase of 3,000 from the previous week's revised average of 355,000." (source: U.S. Department of Labor)
The number was better than forecasts. However, there is a lot of noise in these numbers and I do not use unemployment claims as a key indicator. I am waiting for the updated nonfarm payroll report for April before making a new judgment about the employment situation.
The following is the trend in nonfarm payrolls through the end of March.
I marked the Federal Reserve as "yellow" in the scorecard above because we received mixed messages from the Fed this week.
On Wednesday the Fed released the minutes from the last FOMC meeting. The last meeting was on March 19-20, so this information is a bit stale.
The FOMC's said the following about continuing quantitative easing and the potential for reducing the $85 billion of monthly bond purchases:
In light of their discussion of the benefits and costs of asset purchases, participants discussed their views on the appropriate course for the current asset purchase program. A few participants noted that they already viewed the costs as likely outweighing the benefits and so would like to bring the program to a close relatively soon. A few others saw the risks as increasing fairly quickly with the size of the Federal Reserve's balance sheet and judged that the pace of purchases would likely need to be reduced before long. Many participants, including some of those who were focused on the increasing risks, expressed the view that continued solid improvement in the outlook for the labor market could prompt the Committee to slow the pace of purchases beginning at some point over the next several meetings, while a few participants suggested that economic conditions would likely justify continuing the program at its current pace at least until late in the year. A range of views was expressed regarding the economic and labor market conditions that would call for an adjustment in the pace of purchases. Many participants emphasized that any decision to reduce the pace of purchases should reflect both an improvement in their overall outlook for labor market conditions, as implied by a wide range of available indicators, and their confidence in the sustainability of that improvement. A couple of these participants noted that if progress toward the Committee's economic goals were not maintained, the pace of purchases might appropriately be increased. A number of participants suggested that the Committee could change the mix of its policy tools if necessary to increase or maintain overall accommodation, including potentially adjusting its forward guidance or its balance sheet policies.
(Source: Federal Reserve, emphasis added by author)
The minutes reveal a debate about QE and there are some members that want to cut back. However, this is not new news.
Because the FOMC is so focused on "labor market conditions" as a catalyst for reducing and, eventually, ending QE, the weak nonfarm payroll number for March likely pushes back the timeline for any change to the current pace of $85 billion of monthly bond purchases. Importantly, the FOMC's discussion that was revealed in the minutes happened before the weak jobs number came out.
I continue to believe that the Fed's balance sheet will reach $4 trillion from $3.2 trillion currently. Furthermore, we will likely have QE until January 2014, at least, when Ben Bernanke ends his term as chairman.
There was an interesting WSJ article that discusses when economists expect changes to QE and its eventual end (here). The consensus is that we will have QE far into 2014, though the amount of bonds the Fed buys each month may come down.
In the past, the S&P 500 has performed very well during periods of QE:
SPY data by YCharts
Europe continues to struggle through a weak economic environment. However, the concerns that the Cyprus bailout would spark another global crisis like last summer were exaggerated.
Pimco's Mohamed El-Erian wrote Friday in Cyprus Rescue: From Bad to Worse that the European authorities are continuing to bungle the Cyprus situation.
For now, the problems seem contained to Cyprus. In fact, the euro has rebounded off the Cyprus crisis lows and closed the week at $1.31.
The European sovereign bond markets also do not show signs of contagion as yields in Spain, Italy and Portugal ended the week lower.
S&P 500 Earnings
Earnings season began and 31 companies in the S&P 500 have reported so far. Of those, 18 beat estimates, nine missed and four were in-line.
In my article from a few weeks ago, Roadmap For Navigating The Upcoming Earnings Season And S&P 500's Next Move, I discussed the key things to look for during earnings season. It is too early to judge the earnings in aggregate since only a few companies reported, but I want to discuss a few points.
In my roadmap for earnings, I wrote:
The banks have been a market leader out of the 2008/2009 financial crisis, especially since last summer. However, bank stocks have been weak following the stress test results.
Several of the big catalysts have already played out, at least partially: discounts to book value and the stress test results. We now need new drivers for the stocks, such as more earnings growth and increasing ROE.
I am not looking for outstanding results from the banks. Instead, I am looking to see if the Q1 numbers are enough for the banks to hold onto most of their recent gains.
Seen in this context, the results from JPMorgan and Wells Fargo did what they needed to do. It would have been very hard for JPMorgan and Wells Fargo to deliver big upside surprises considering the expectations going into earnings and the strong performance of their stocks.
I am not too concerned by the initial drop in the shares of JPMorgan and Wells Fargo because it was limited. It will be more interesting to see the reaction-to-the-reaction over the next few days.
There are more banks earnings to come, so it is still too soon to judge the sector.
Apple (AAPL) reports earnings on April 23. Apple's stock price tested the $419 low last Friday and bounced back this week to $429.80.
Everybody is looking for a low in Apple, but earnings look like a wild card.
Earnings estimates for Apple continue to come down, as they have all quarter.
(Source: Yahoo Finance)
Apple is an important stock because it represents 2.9% of the S&P 500 and has a large weighting in the NASDAQ (QQQ). It also widely watched and important for sentiment. Finally, with the troubles in the tech sector, discussed below, Apple could be an important safe haven, if its results are good enough.
The tech sector continues to struggle.
Furthermore, IDC revised lower its PC sales forecasts. IDC now expects Q1 PC sales to be down -13.9% compared to last year. Previously, IDC expected a -7.7% decline. The news sent shares of Microsoft (MSFT), Intel (INTC) and others lower.
I wrote about my negative outlook for Microsoft here: Microsoft Is On Citigroup's Dividend List, But Not Mine and the new forecast from IDC supports some of the arguments that I made.
Considering this weakness, I am very cautious about tech stocks now and will try to avoid holding them going into earnings. Instead, I prefer to buy some tech stocks after they fall on bad earnings. This was my strategy with Oracle and it has worked out well so far.
The metals/mining/materials sector has been weak. I am not expecting a turnaround, but I want to see if the results can halt the steep decline or if they become a catalyst for another leg lower.
The Materials Select Sector SPDR Fund ETF (XLB) rebounded off the lows of Friday, April 5, but had another tough day this past Friday, together with the rest of the sector.
I am watching to see if the XLB can stay above $38 during earnings season.
Metals have also been week, including copper as seen in the price action for the iPath Dow Jones-UBS Copper Subindex Total Return ETN (JJC).
Earnings season began with Alcoa's results, which I discussed here: Alcoa Outlook After Q1 Earnings: Aluminum Weakness Still Overshadows Downstream Success.
Alcoa's share price did not move much in the immediate aftermath of earnings. Alcoa has already fallen over the last few months and years, so bad news has been priced in. However, Alcoa did fall on Friday with the rest of the sector.
It is still too early to tell what metals/mining/materials earnings will bring, but the price action last week, especially Friday, was not encouraging.
The S&P 500 continued to climb as earnings season began. It has a high multiple, implying lots of expectations. It is too early to tell what earnings will bring, but there are a few early data points.
The earnings from JPMorgan and Wells Fargo were not stellar, but seemed good enough to continue to support their stock prices after a nice rally. Tech continues to be weak and IDC's revised PC sales forecast is not a good sign. Tech stocks continue to provide disappointing earnings and fall. Also, The materials sector has been lagging and is up for a big test with Q1 earnings.
The S&P 500 has been led by defensive sectors, such as consumer staples and healthcare. That can last for a while, but it will need rotation for another big move higher. I am cautiously optimistic going into earnings and do not want to get too negative until I see evidence for it.
Aside from earnings, the other three indicators - jobs, Federal Reserve policy and Europe - do not seem like catalysts to end the rally.
The S&P 500 cannot move-up forever without earnings to support it and at some point there will be a correction. However, the evidence is not there yet.
Additional disclosure: I may trade any of the securities mentioned in this article at any times, including in the next 72 hours.
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