Focus On Earnings

Includes: DIA, QQQ, SPY
by: Financial Sense

By Thomas J. Smith, CFA

As we near the conclusion of a good year, talk turns to the next. Many strategists just take the year-end levels and add 8% to 10% and come up with their targets for the next. Not rocket science but, given the past few years' returns, not too far off the mark. Let's look at things a little more closely.

Here again are the themes I am looking at and will continue to look at. The Leading Economic Indicators (LEIs) have been improving for quite some time. Remember, the market itself is a leading indicator. The LEIs point to an improving global economy. Higher global growth rates lead to a potential acceleration in earnings growth rates. Also, inflation remains subdued. Commodity prices have come down since 2001. Lower inflation and accommodative central bankers have created an increasing stimulus in the pipeline for two years.

As inflation ebbs and growth accelerates, we see, for the first time since the 1990's, non-inflationary growth. In this environment people are willing to pay more for $1 worth of earnings and price-earnings multiples expand.

In order for the averages to move higher, we need to see the denominator of the P/E multiple move higher. By most historical measures stock prices are near historical market averages on a P/E basis. My focus will continue to be on the E of the multiple. Accelerating earnings growth in 2014 is needed to push prices higher.

There continues to be more right than wrong with the technical picture of the market. A positive divergence developed last week. The major averages were all down the first four days of trading last week. Talk of the "bubble" in stock prices was perking up. At the close of trading last Thursday, a positive divergence developed. Some -- but not all -- of the major averages I follow closed below near-term support. The Nasdaq and Russell 2000 held support ahead of the employment data released Friday morning.

Then, "Boom!" The market liked the data and stocks traded aggressively higher Friday. It is amazing how often stocks pull in to support right before major data points. With 72% of the stocks in the S&P 500 in sound shape technically (63% in the secondary markets), the bulls get the benefit of the doubt.

The rally on Friday was a little weaker than it would appear as breadth was not as strong as I would like to have seen. The Nasdaq and Russell 2000 holding 3790 and 1117 respectively was your sign that selling pressure was weakening.

Here are your support levels for the S&P 500/Dow/Nasdaq/Russell 2000: 1778/15,790/4000/1110. If the following resistance levels are taken out, the rally will gain steam: 1815/16,180/4070/1148.