Despite the one day sell-off experienced by the major US equity averages on Thursday, the outlook appears to be relatively positive for the bull case. In a recent post (see Welcome to the Santa Claus rally), I cited analysis from Thomson-Reuters indicating that much of the Street expectations for Q4 earnings growth did not come from revenue growth, but from share buybacks and other factors, such as margin expansion.
SP 500 Components of Earnings per Share Growth
I wrote that I would be watching the PMI releases closely, largely because strong numbers would provide better support for revenue growth and thus alleviate the need for the other cited factors to do the heavy lifting. So it came as a pleasant surprise that the Markit PMI and the Manufacturing ISM reports came in either in-line or ahead of expectations, which raises the odds of more positive top-line surprises this Earnings Season. Scott Grannis at Calafia Beach Pundit wrote that the December PMI report was consistent with GDP of at least 4%.
No signs of EM panic
As well, I had been concerned that emerging market bonds might catch another bout of Taperitis, just as they did during the May-September period when the Fed started talking about tapering (see Watch the risk premium! (Fed taper edition)). Then, the selloff got to the point where the world was on the verge of an EM currency crisis that had the potential to spill over into the global financial system.
As a measure of the stress in EM bonds, the chart below shows the relative performance of the EM bond ETF (EMB) against US junk bonds (HYG) - a junk vs. junk measure. As the chart shows, EM bonds have weakened against US junk but there has been no signs of panic and relative support is holding - so far.
Still a risk-on environment
Despite Thursday's stock market selloff, I am still seeing signs that the risk-on trade being dominant. The chart below of the relative performance of Consumer Discretionary stocks (XLY) against Consumer Staple stocks (XLP) as a measure of Mr. Market's risk appetite shows that Discretionary still outperforming Staples, even on Thursday.
Similarly, the relative performance of the Broker-Dealers (IAI) against the overall market (SPY) is a sensitive barometer of risk appetite. IAI remains in a minor relative uptrend against the market and managed to beat the market on Thursday despite the sell-off.
These market internals, combined with the lack of panic in EM and positive macro readings are all supportive of the continuation of an intermediate uptrend in stock prices. To be sure, stock prices have gotten a little extended in the short-term and the market could pull back at any time. Moreover, volatility will likely increase as we move into Earnings Season.
Nevertheless, my inner trader tells me that the intermediate term bull case for stocks remains intact, for now.
Disclaimer: Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.” None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.