U.S. indexes are experiencing a small correction as Wall Street traders find this Middle East unrest a “justified reason” to offload stocks and lock in profits. Still, this is no time to enter the “Fear Factor” or start getting down on the prospects of the U.S. economy. In our opinion, the U.S. is still driving ahead on this rough road of economic recovery.
If anything, this mini-correction looks like a new area where the S&P 500 (SPY) will likely start consolidating before it makes another leg higher. Currently, we aren’t overly concerned with the short-term effects of this correction, given that we haven’t seen anything fundamentally alter the U.S. economic recovery. Instead, we see this as an opportunity to take some limited action, since the S&P 500 hasn’t really let up in terms of its upward trajectory for some time. We are more bullish on the S&P 500 now, given a weak U.S. dollar, the debacle in Libya, and the current market correction itself.
Taking Advantage of a Weak U.S. Dollar
Roughly 60% of today’s S&P 500 earnings are actually generated outside the U.S. This might be a surprising fact to some investors, but it’s the truth, and something to take note of. Basic macroeconomics tells us that when a country’s domestic currency weakens in value, exports abroad should increase accordingly, as its products become more cost-competitive in foreign markets.
Given the fact that the U.S. dollar has weakened in relation to many U.S. trade partners, we think there should be continued and increased earnings strength from sales abroad for the S&P 500. The first quarter of earnings season for 2011 definitely indicated that this was actually occurring. In addition, we expect the dollar to remain “cheap” for 2011, and accordingly anticipate this trend in foreign sales to only increase.
As U.S. companies bring foreign earnings back home at favorable exchange rates, we feel that in conjunction the S&P 500 should continue posting strong earnings. Two examples that exemplify this reality currently are Caterpillar (CAT) and Abercrombie & Fitch (ANF), which both posted strong earnings that were boosted by sales abroad.
Taking this one step further, we hope that a weak dollar might even help reduce the current unemployment rate as U.S. GDP numbers improve. In the short-to-medium term, a weak dollar makes our bullish conviction on the S&P 500 even stronger -- regardless of whatever short-term volatility the market experiences.
Libya’s Mess Won’t Derail the U.S. Economy
From a capital markets perspective, Libya’s mess is exactly what it sounds like -- it’s Libya’s mess. As we stated in a Feb. 22 post, we feel that this has been the best excuse in a while for Wall Street to justify selling off in order to cash in profits. Looking at the performance of the S&P 500, we were correct as it dipped down to -3.5% at one point but closed out the week only down -1.63%.
There is a debate currently going around on whether the U.S. even imports any oil from Libya at all. Even if we do import a nominal amount, it’s nothing compared to the amount of oil imported from Canada on any given day. At this point Brent Crude Oil (which is what Western Europe tracks) is pricing almost 15% higher than Nymex oil prices (U.S.) because Europe imports more oil from Libya than the U.S.
The pricing spread between the Nymex oil and Brent oil makes it clear that the U.S. economy need not worry very much about a Libyan oil disruption, to say the least. Rather, U.S. oil prices have spiked here out of fear that a much more substantial oil-producing country such as Saudi Arabia might not be able to keep its protesters calm and off the streets. Moving forward, we don’t see the Libyan fiasco materially affecting and/'or derailing the U.S. economic recovery.
Buying On Dips
Look at a chart of the S&P 500 over the last six months and the one thing that becomes clear is that it has been on a tear for a while. The last time the S&P 500 really slowed down was when it corrected off of a positive 64.55% bull run that started when the market bottomed on 03/06/2009 and ended on 04/23/2010. Even if an investor bought the S&P 500 on 04/23/2010, right before the market violently corrected over the spring and summer, he would still be up 9.14% today. Not a shabby return, considering the pummeling that any investor took over the 2010 summer ... and the fact that this return is in less than a year on a major U.S. index.
If we're looking to buy an index such as the S&P 500, we’re definitely taking a long-term view -- not a day-in/ day-out view. What we care about as investors is that the fundamental economic drivers are in place and holding for the U.S. economy to improve with time.
As well, we care about getting in before everyone else gets exuberantly bullish for the exact same reasons that we listed above. The take away point here is that no investor knows with 100% certainty whether any correction is going to be small or big, but what does make sense is buying the S&P 500 on justifiable dips when the U.S. economy is improving and the index isn’t bought on a multi-year basis.