The Dow broke through 13,000 for the first time since May of 2008 Friday, but it could not close above the important mental threshold (there is no technical resistance at this level). The market has been in a risk-on or bullish mode for most of 2012, with the Dow gaining more than 12% and the Nasdaq up a whopping 20% year to date. The question now becomes what is the next step for the market? The Dow has gained more than 2,000 points in a few months and all seems right with the world. This is extremely similar to the 2,000 points we lost last summer when the media pundits were screaming that we were entering another recession. The market seems to be going up just for the sake of going up.
Is there fundamental reasons why the market should still be bullish about the future? Absolutely, the price to earnings ratio for the S&P 500 is far below its historical average (approximately 13 now vs the historical 16 PE); companies continue to increase revenues and earnings. However, margins are likely to be a problem moving forward for many companies that try to pass higher costs onto the consumer. The first of which is fuel. Fuel plays such an important role in the economy that the recent increase in oil prices (the chart below shows crude oil since the beginning of February) has a distinct possibility of derailing the economic rebound.
Fuel is pivotal to the strength of the economy because not only does it affect the production of the goods, but it also affects the transportation of the goods to the end user and the end user getting to the store. Living in New York City, I am fairly insulated from the surge in fuel costs, however, I recently spent some time in Philadelphia and the price at the pump was definitely a shock to me, especially when I needed to fill up my car with gas.
Results this earnings season were not that good either. Sure there were some good surprises, but take this mornings plethora of earnings releases and the majority of them were beats, but it was the guidance that is pressuring the companies. Dell (DELL) came inline with expectations but its revenue guidance for the current quarter came up a bit short. TJ Maxx (TJX) beat on both the top and bottom lines, but still the stock is trading lower. The problems in Europe and a potential economic slowdown in China (the government lowered the reserve requirement overnight), also are weighing on the future prospects for stocks.
I am still a bull, don't get me wrong, but I do think that over the next three to four weeks we see a little bit of a correction. Not the 10% correction that would send us out of the bull market, but something that will cool the heals of investors. In times like this, I like to concentrate on solid fundamental companies that specialize in real world demands. Two of my favorite spaces for this type of market are the railroads (JP Morgan downgraded the sector Friday) and beverages. While you may not see the type of return you would see from a tech stock that continues to move higher (think AAPL), you do get the lower degree of risk. My favorites in the railroad industry are CSX and Union Pacific (UNP). CSX is one of the best run companies (not just rail companies) that I have come across, and with a steady earnings improvement, strong pricing power, and a good dividend policy, I like this stock for the long term, as well as for some short term protection. UNP is just a beast. It is the largest of the rail operators and has an amazing balance sheet, strong pricing power, and a great management team.
With respect to beverages, I like the Coca-Cola Company (KO) and the Dr Pepper Snapple Group (DPS). KO is the 800 lbs gorilla in whichever room it is operating, while DPS is a company that I like for growth prospects. There is some significant resistance for DPS at $40.00, but the stock has beat earnings estimates in each of the past four quarters, and beat on both the top and bottom lines handily in the fourth quarter and issued strong guidance for 2012.
Looking forward, I think we continue to see a bull market, but one that is going to have its fits and starts. I would not be drinking the Kool-Aid at this 13,000 milestone and jumping into the market with both feet. However, I would have some downside protection.