Good morning. As I've written a time or twenty, the purpose of my morning market missive is to identify the forces that are driving the market. The thinking is that if one can understand what is happening to the stock market in the short-term then you ought not be surprised when the really big moves occur. And let's be clear about one thing; the real money in this game comes from getting the really big moves right such as the massive decline seen in 2008 and early 2009, the move off the bottom in 2009, the "everything is a buy" rally (based on QE2 in 2010), and the mini bear of 2011.
Speaking of last year's mini bear, it certainly feels like "déjà vu all over again" right now as we're seeing the same pattern and the same issues/concerns, all at exactly the same time for the third year in a row. As was the case in the spring/summer of 2010 and 2011 traders are currently focused on three things: a slowdown in global economic activity, the debt mess and the potential for contagion in Europe, and the fiscal/debt situation here in the good 'ol USofA.
However, unlike the -16% decline seen in the summer of 2010 and the -19% mini bear that occurred during the "Sell in May and go away" period in 2011, the 2012 summer of discontent has been less painful (well, so far at least) as the S&P has fallen just -9.93% from the high seen on 2-April to the low of 4-June. So, with the situation in Greece appearing to be "solved" again (yes, again, and at least for now) and the EU leaders looking like they will begin moving toward a United States of Europe, the question at this stage of the game is if there are reasons to be optimistic going forward.
To be sure, it is easy to see the negatives at the present time. For starters, the economic data has been deteriorating in the U.S. for the past month. Evidence to be submitted here includes the reports on Weekly Jobless Claims, Philly Fed, Industrial Production, Consumer Sentiment, Empire Manufacturing, Retail Sales, ISM Manufacturing, Q1 GDP, and the all important Nonfarm Payrolls. In response to the punk data, even the Federal Reserve has cut their growth forecast for the U.S. (while actually increasing their projections for the unemployment rate). And while the reports have not debunked the "muddling through" thesis, the slowdown in growth leaves the country vulnerable to economic shocks/events.
A key point in the global macro case is the weaker-than-expected economic outlook isn't limited to the United States and as such, the U.S. is unlikely to "decouple" from the rest of the world. Recall that most of Europe is either already in recession or on the brink while China, which is currently considered the world's economic driver, at least as far as commodity use is concerned, is clearly slowing -- as is India, Brazil, etc. On that note, China is likely to be a focal point today as a New York Times article provided evidence that Chinese officials have been falsifying economic statistics in order hide the true depth of the slowdown.
Why do we care about such macro issues? After all, aren't companies like Apple (AAPL), Monster Beverage (MNST), and Amgen (AMGN) doing just fine, thank you? The problem is that the earnings game is never about current earnings, it's about the game of expectations versus reality AND the outlook going forward. And for those of you keeping score at home, of the 98 companies that have updated their guidance in front of the upcoming earnings season, 16 have increased earnings guidance while 35 have cut their expectations.
One example here would be Procter & Gamble (PG), which last week cut its estimates for the coming quarter. The company said the problem was "slower than anticipated" sales growth due to "market-share weakness in developed countries." P&G went on to say that they will be slashing costs in order to try and perk up earnings -- and, of course, will cut jobs to do it. And if this becomes a corporate theme again, the bottom line is unemployment is going to rise.
Then if you toss in (a) the fact that Europe is reinventing the phrases "doing the least amount possible" and "kicking the can down the road," (b) the impending "fiscal cliff" that is due to hit the U.S. in six short months, (c) the fact that the Fed policy is either not working or certainly less effective than it has been in the past (can you say "pushing on a string?"), and (d) fiscal policy is off the table due to the brinkmanship taking place in Washington, well, it is easy for investors to be sitting with their bear hats on at the present time.
Yet despite all of the negatives, this year's summer swoon has been shallower than the last two, the volatility has been less intense, and stocks are up smartly from their lows seen at the beginning of the month... Which brings us to the question of if there are reasons to be optimistic going forward.
Whether or not the positives the market has going for it right now are enough to move stocks higher or merely provide a cushion for further declines, there are a couple areas that provide reasons for hope. First and foremost here is the valuation picture. The median P/E for the stocks in the S&P 500 began the year at lower levels (remember, corporate profits moved up to record levels during 2011 while the S&P was basically unchanged). And although earnings expectations are falling at the present time, they were not overdone to the upside this time around. For example, in 2010 the median P/E was 20.1 going into the summer swoon. In 2011 the median P/E was 18.4. And this year, the median P/E is 17.3. As such, the "reality vs. expectations" game does not carry as much downside potential right now.
In addition, corporate dividend payments continue to rise. And when you combine this with the current near-record low yields on T-bonds, stocks look favorable on a valuation basis. So, while I could continue to bore you with all kinds of valuation statistics, the bottom line is that the valuation backdrop right now is much better than it was during the last two years.
Another factor that could (key word) provide some support for stocks going forward is the fact that investor sentiment has once again plunged to what can be considered extreme levels. While our intermediate-term sentiment model has not reached the degree of negativity seen during the prior two summer swoons, it is worth noting that (a) the level is consistent with correction lows and (b) our short-term sentiment gauge did hit the levels seen during 2010 and 2011. The message here is that those investors who wanted to sell may have already done so. Obviously the computers can push the market any way they want on a daily basis, but from a from a bigger-picture perspective, there may be fewer sellers left going forward (remember that mutual funds have continued to see outflows this year).
Finally, it is important to remember that this is an election year. And the bottom line is that the message from the election year cycle is fairly clear as stocks tend to rise from the fall to year-end. So, despite your politics, this is one area that should provide investors with a reason or two to be optimistic looking forward.
Will any of this be enough to offset the pervasive negativity going forward? Frankly, I don't have an answer (my crystal ball is still in the shop). However, if stocks manage to hold the June lows for the rest of the summer, I would suggest that there are indeed reasons to be optimistic. But, in looking at the calendar, it is clear that there is still plenty of time for the summer of discontent to resume. Thus, we will continue to play the game conservatively until some optimism can return.
Turning to this morning ... Traders are clearly not in an optimistic mood this morning in light of the fact that (a) Spain officially asked for aid to recapitalize their banks, (b) a NYT report suggests that China may be falsifying data, and (c) the BIS said the world's central bankers are basically out of bullets.
Major Foreign Markets:
- Australia: -0.53%
- Shanghai: -1.63%
- Hong Kong: -0.51%
- Japan: -0.72%
- France: -1.95%
- Germany: -1.78%
- Italy: NA
- Spain: -2.75%
- London: -0.68%
- Crude Oil Futures: -$0.86 to $78.90
- Gold: +$1.10 to $1568.00
- Dollar: higher against the yen, euro and pound
- 10-Year Bond Yield: Currently trading at 1.621%
Stock Futures Ahead of Open in U.S. (relative to fair value):
- S&P 500: -13.07
- Dow Jones Industrial Average: -94
- NASDAQ Composite: -24.2