The debate concerning the outlook for growth in the equity markets is heating up. Looking at the headlines it is a flip of the coin on which side of the argument you fall. The indecision has caused some intraday volatility as earnings, economic data, economist and stock analyst shift sentiment almost daily towards the markets.
I wanted to look at 5 reasons to like or dislike stocks looking forward:
One – Earnings have been upbeat with 50% of those reporting beating expectations. The outcome overall has been above expectations and forecasts for the majority are positive for the balance of the year. Earnings are the ultimate determination for the price of a stock and if the expectations are for growth, the market prices stocks looking forward. Some earnings were great, but got no respect from investors. Apple and Intel come to mind. However, they have since bounced as buyers saw future growth and opportunity. Good earnings eventually win investors over. Thus, one vote in the positive category to like stocks and the market looking forward is positive earnings growth.
Two – Sales or revenue growth has been positive from those reporting earnings. In order to grow earnings you generally need revenue growth. The last twelve months companies have grown earnings by cutting costs and jobs, but you can only cut so much in order to grow earnings. The railroad sector has reported stronger than expected earnings (see number one) and the reason was higher revenue due to increased traffic or shipping. The automobile and commodities (coal) were the largest increase. Rising demand trickles through the economy. The transition to revenue growth points to a growing economy which points in the direction of liking stocks.
Three – Improving economic data remains gradual, but steady. The estimates of 3-4% GDP growth is in favor of stocks, however you have to buy into the premise of this growth rate. I am not quite as optimistic relative to real growth in the US economy. Why? The producer price index has been rising with the increase cost of commodities primarily. Gasoline is up more than 30%, soft commodities have climbed better than 20%, food costs are up more than 20%, etc. The rise in cost at the wholesale levels eventually has to be passed on to the consumer or margins shrink and thus, earnings fall. Price increases impact the discretionary spending by the consumer. The ability to pass this cost on to the consumer is another issue that will impact the consumer discretionary products sector. Durable goods have an equally challenging prospect. The price of gasoline is at $3.10 per gallon versus $2.60 last summer, or a 20% increase. The increase at the wholesale level was more than 30%, not an equal pass through. Thus, a look at the refinery stocks shows a decline in margin, which is a direct impact to profits/earnings. Which the prospect of has pushed stock prices lower. The rising costs on the wholesale level is a vote in the camp to dislike stocks, or at least some sectors.
Four – Political static or interference will inject volatility in the markets. The most recent was the vote last week by Congress to repeal the healthcare bill. It pushed the healthcare sector down 3% and the healthcare providers were down more than 5%. This type of “help” from Washington isn’t going away anytime soon. The financial regulatory bill is creating challenges in the financial services sector, some good, some not so good. The consumer credit portion of the bill intended to help, has actually hurt the availability of credit at the lower end of the ladder. MasterCard and Visa share prices have been impacted short term on the uncertainty. Good or bad, these acts by Congress have an impact on the price of stocks in their repsective sectors. The current atmosphere in Washington is cooperation for job creation… I am not holding my breath, but this points to the need to watch stocks directly in the crossfire of Washington.
Five – Value over growth? While this is another debate within the debate relative to stock growth, value is taking the lead. The large cap stocks, as we discussed earlier this week, have out shined the small cap and growth stocks the last four weeks. I know that is a short term period, but the January effect is all about small caps taking the leadership of the broad markets. There are periods when value stocks outperform growth stocks, and we may be heading for one of those periods. The bias is leaning in that direction and one worth watching as this year unfolds. Either way, this argument falls in the category of liking stocks.
There are many more reasons or arguements on both sides. Take the time to determine which camp you fall into, and invest according to your convictions. I am on the side of liking stocks and the outlook is positive for the next 12-18 months. There will be volatility along with disappointments, but the overall outlook falls on the positive side. A short term pullback or correction would be a opportunity to add to, or establish new positions in equities.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.