Last Thursday David Tepper, the highest paid hedge fund manager in the nation in 2013, put out comments that he was "nervous" about the levels of the market right now. The noted money manager has made several great calls on the markets since the financial crisis and his cautious words were one of the primary drivers behind the one percent decline in the markets last Thursday.
I think Mr. Tepper is right on his pessimistic outlook for equities for a variety of reasons.
Too Far, Too Fast:
The market had its biggest one year rally since the late 90s in 2013. The S&P 500 gained some 32% for the year including dividends. Unfortunately, most of this rise was fueled by multiple expansion and not earnings or revenues growth. S&P earnings only advanced 5% year-over-year on the back of just a 2% rise in revenues overall. Obviously it was highly unlikely this sort of multiple expansion could continue this year without a significant acceleration in earnings growth.
Earnings Growth Tepid & Slowing:
Unfortunately for investors this has not occurred so far in 2014. In fact, earnings growth has even decelerated from the tepid levels of 2013. Over 90% of the S&P 500 companies have reported results so far this earnings season. Earning are up just 2.1% year-over-year. The consensus is calling for 6% growth Y/Y in Q2 but that is unlikely to be achieved. Remember when Q1 began, the consensus was calling for 5% Y/Y growth.
What is particularly disappointing is that S&P 500 companies have spent hundreds of billions of dollars buying back shares over the past year. Without that support, earnings would have been down Y/Y in the quarter. The bottom line is investors are paying 20% to 25% more per earnings unit than they were to start 2013.
Federal Reserve, GDP Growth and Interest Rates:
That would be fine if the economy was actually expanding from the averages of the past four years and robust earnings growth lay ahead, but that simply is not the case. The economy basically contracted in the first quarter. Yes, horrid weather was a major headwind. However, it is hard to imagine that the U.S. economy will achieve the annual 3% GDP growth most pundits were predicting at the first of the year for 2014.
I always thought the economic consensus to begin this year was nonsense. If the economy could only achieve 2% GDP growth coming off a deep recession with the Federal Reserve priming the pump at every opportunity, how was it supposed to achieve 3% GDP growth as the Federal Reserve was starting to pull back on their extraordinary liquidity measures? These predictions look destined to join other overly optimistic wishes like the "Summer of Recovery" in the dustbin of history.
The drop in yields on ten year treasuries from over 3% to start the year to just over 2.5% currently seem to confirm the market is saying the economy will probably continue to plod along at the same tepid 2% GDP growth we have been stuck in for five years now in the weakest post war recovery on record. The risk around economic growth also seems to be on the downside here.
Momentum Sectors Are Selling Off:
The momentum stocks and sectors that led the market in 2013 started to sell off in early in March. Momentum stocks like Netflix (NASDAQ:NFLX), Amazon (NASDAQ:AMZN) and Tesla Motors (NASDAQ:TSLA) have had deep declines over the past few months. Small caps have also experienced deep sell-offs especially in the biotech arena which had so many big winners in 2013. I expect this pull back to continue.
The high yield sectors and growth at a reasonable price plays like Apple (NASDAQ:AAPL) that have led the market throughout 2014 should continue to do. I think long time pundit Ralph Acampora hit the nail on the head CNBC the other day when he compared the current market to the one twenty years ago in 1994. He is forecasting a "stealth bear market" where the main indices stay relatively flat while the high momentum stocks continue to see a deep sell-off that has been in place since early March.
I think investors should position their portfolios accordingly. Tomorrow we will look at a few reasonably priced stocks that have led the market so far in 2014 and are likely to continue to do so.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.