Standard and Poor's Blindsides U.S. Market

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 |  Includes: AGU, CEO, CF, CFPZF, CVX, SDS, SPXU, TLM
by: Chris Damas

Standard & Poor’s debt rating service downgraded the sovereign credit rating outlook for the United States to "negative" – U.S. and Canadian stock markets dropped quickly.

The DJIA futures were already down 65 before the announcement due to another half point increase by the Chinese for their bank minimum reserve requirements.

Crude oil futures were also down almost $2 on Saudi comments that the market is oversupplied.

An hour into trading, the DJIA had dropped to a low of 12,099 or 242 points and is currently down 207 at 12,132.

The Canadian S&P/TSX index is 13,598 down 200 points helped slightly by a rally in gold which was up $13 to $1,498 on the June contract, but is only up $2.60 now.

What’s my take on this latest bad news Monday morning?

First – I’ve been bearish for the last few weeks and have been waiting for the 2011 DJIA rally to sputter.

I have been going "short" on the S&P 500 via two ETF’s – SDS (X2) and SPXU (X3).

I have felt geopolitical events including the Japanese disaster and the Euro Credit Crisis would finally slow U.S. economic growth and corporate profit growth.

This is after being bullish since the summer of 2010 to Christmas and then again in early 2011.

However, valuation on the DJIA is not excessive as many pundits have pointed out, manufacturing has been strong and major component earnings growth has been strong.

Here are some metrics for the top 30 DJIA using Friday’s closing prices and my spreadsheet I consult when the market requires some assessment of value:

  • Average P/E based on analyst 2011 estimates: 12.9X
  • Average yield based on last dividend announcement: 2.7%
  • Average 2011 EPS estimates over 2010: 23%
  • Average Dividend Payout: 33.4%

Conclusion

Investors should be wary of the market’s vulnerability to not only the excessive debt levels around the world, but also the likely default by Greece in the near term.

The U.S. dollar rallied (euro dropped) and this always puts a crimp in the stock market.

However, most DJIA components will be announcing Q1 earnings over the next couple of weeks. Dividend increases could maintain positive sentiment for stocks relative to bond yields.

Most major DJIA components go "ex" their declared dividends in early to mid- May.

I would expect the U.S. market to continue to tread water but I feel now is the time to start raising cash, if you haven’t done so already.

Precious metals, crude oil, gasoline, grains and other commodities are on a different trajectory from the overall industrial bellwether and should be treated on a case by case basis.

The Canadian dollar often softens the drop in our resource stocks and much of the damage to resource equities has already occurred over the past couple of weeks.

I continue to be moderately bullish on crude oil and major Canadian energy stocks such as Talisman (NYSE:TLM) and Nexen (NXY).

U.S. gasoline demand may contract due to $4 fuel but the new normal range for gasoline is probably higher and consumers will cut back in other areas to drive their vehicles. Chevron (NYSE:CVX) reported excellent margins for refining and marketing gasoline through March in their recent Q1 interim update for analysts.

I am concerned over the Midwest U.S. floods delaying crop planting and would not be over-exposed to CF Industries (NYSE:CF) and Agrium (NYSE:AGU) until the ground dries out sufficiently to allow American farmers access to their fields.

I have guided caution on Canadian and U.S. forest product companies due to over-valuation caused by euphoria over potential sales to Japan. Wait for Q1 earnings results to come in. Since my warning, Canfor (OTCPK:CFPZF) dropped from over $15 to below $13.

Disclosure: I am long NXY, TLM.