Why The Market Rally Will Likely End This Week

by: The Independent Investor

The market doesn't seem to go down any more. While disappointing news out of Europe, weak industrial data from Asia, and disappointing earnings reports from major companies such as Apple (NASDAQ:AAPL) have put pressure on stocks over the last month, the market has consistently rallied for nearly a month.

The S&P 500 and its tracking exchange traded fund, SPY (NYSEARCA:SPY), has rallied nearly 20% from the lows of last year, and stocks such as Apple are up over 40% this year. Apple and market leaders in cyclical sectors, such as GE (NYSE:GE), Caterpillar (NYSE:CAT), and Citigroup (NYSE:C), have also rallied particularly hard over the last couple weeks. Energy stocks such as Exxon-Mobil (NYSE:XOM), Chevron (NYSE:CVX), Schlumberger (NYSE:SLB) and Halliburton (HLB), have also been strong performers over the last month as well, with energy prices have rising over 10% in the last couple weeks.


The first reason why the recent rally will likely reverse in the coming week is because the market leaders in the Nasdaq such as Apple and Intel (NASDAQ:INTC) are likely fairly valued. While Intel had a strong recent earnings report, and Apple disappointed only mildly on recent iPhone sales, PC shipments were still flat year-over-year in the second quarter, tablet sales continue to increase at a far faster pace than PC sales, and the very poor recent guidance of leading hard drive makers such as Seagate (NASDAQ:STX) suggests PC growth will likely remain fairly weak this quarter. The strong sales growth companies such as Apple have recently seen in tablets also suggests that products such as the iPad are likely increasingly cannibalizing PC sales as well.

Apple also isn't expected to release the blockbuster iPhone 5 for several months, and analyst estimates for the iPhone 5 are likely priced into the stock, since traders and investors have known about this companies hotly anticipated product launch for nearly a year. Analyst estimates for the iPhone five have also come down less than 2-3% even as companies such as McDonald's (NYSE:MCD), Phillip Morris International (NYSE:PM), and Yum (NYSE:YUM), continue to report weak a significant recent slowdown in consumer spending trends in China and Europe, and Apple's particularly poor recent sales numbers in Europe were well-below analyst expectations.

The second reason that the market will likely sell-off this weak is that oil and other major commodities are likely overbought. With the dollar still near three year highs, Iran now cooperating with international authorities on its nuclear program, and new and significant oil production from Libya and Iraq continuing to come on-line, energy prices have fallen by over 30% since early March. Oil production in North America also continues to rise, and inventories in the U.S. are at the highest levels these numbers have been in at in several years despite being fairly bullish of recent.

While the weak import data in China and poor growth rate in the country's real estate and infrastructure sector has put pressure on resource and commodity stocks for most of the last year, there are now strong new signs that consumer spending in the EU and China continues to slow significantly. Gas prices remain high in Europe and China, and weakening economic activity in the EU and the world's second largest economy could continue to significantly pressure energy prices.

The third reason why the market will likely remain weak in the near-term is because many market leaders in cyclical sectors are overbought. Cyclical stocks have also rallied hard over the last month, with market leaders in the industrial sector such as GE, Caterpillar, and Boeing up over 10% in the last month.


While cyclical stocks have sold-off hard since mid-April, many market leaders in cyclical sectors such as GE, Boeing, and Caterpillar, have rallied nearly 10-15% in the last several months. While these companies did have fairly strong earnings reports, management at these industry leaders issued fairly cautious guidance, and GE and Boeing now trade at around 12x forward earning estimates, while Caterpillar currently trades at around 10x average estimates for next year's likely earnings. While these companies valuations seem reasonable, most analysts are expecting mid-single digit earnings growth for the S&P 500 over the next year, and the economic environment remains weak.

To conclude, with most leading industrial companies issuing fairly cautious guidance, traders and investors are unlikely to be willing to pay more than 11-12x forward estimates in today's weak economic environment. While the major indexes have rallied nicely over the last couple months, PC growth is likely to be fairly limited this year, and companies such as Apple will likely wait until winter to release major new products. With Chinese leaders showing little willingness to pursue more aggressive fiscal and monetary stimulus of late and the Fed continuing to be fairly hawkish on possible new monetary stimulus, the market will likely have trouble moving higher in the near-term.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.