What a week for the major US stock markets (and China, but more on that in a minute), as the S&P 500 took out multi-month resistance, at 1,422 – 1,424 and closed the week up 2.75% to close at 1,437.92. The Nasdaq 100 also traded above a key technical level – taking out 2,806 or the 50% retracement level of the March, 2000 high and the October, 2002 low, and closed the week up 2.59% to 2,825.11. The Nasdaq Composite finished higher on the week by 2.88% and the Dow Jones 30 was up 2.35%.
The headlines for the week were varied as to the reason for the rally:
1.) Draghi and the ECB supported bond-buying in the Thursday morning press release, which helped the Spanish bond auction and indicates that Europe is committed to the euro and the continent continues to press toward a long-term debt solution that looks like it will include some “growth” initiatives;
2.) While Thursday’s ADP report looked like it might lead to an upside surprise in Friday’s jobs report, in fact the August payroll report disappointed at just +96,000 jobs created, versus the +130,000 expected;
3.) The ISM non-manufacturing report released on Thursday was better-than-expected at 53.7. I consider “ISM non-manufacturing” to be the US services report, and since 80% of US GDP is services, I consider this ISM number to be far more important to the US economy than ISM manufacturing. However I am not an trained economist, therefore it is often prudent to avoid judgments like the above.
4.) Late Thursday, China committed to a $157 billion infrastructure build-out of 60 projects that sent the Shanghai index up 3.7% on the heaviest volume in months, and sent the basic materials and precious metals sectors soaring on Friday.
As Jeff Miller of “The Dash of Insight” wrote weeks ago, quoting a 3rd party, “sometimes things can go right” and despite the record pessimism around stocks and the record inflows into bond mutual funds, August and September stock market returns are pretty healthy.
One thing I’m sure of regarding the recent rally, is that it doesn’t appear to be earnings driven: while one of our spreadsheet metrics has turned positive, the fact is – according to ThomsonReuters – 2nd quarter, 2012 earnings are still expected to grow at 1.3% ( ex Bank of America and the financial sector) and 3rd quarter, 2012 earnings, which we continue to think will be the bottom for this cycle in terms of the earnings slowdown, are expected to decline year-over-year at a -2.1% rate.
The forward 4-quarter estimate for the S&P 500 estimate as of late last week was $108.02, exactly where it was 1 week ago.
In other words, current earnings news and revisions dont appear to be the catalyst for this recent market rally. We think corporate earnings are troughing, but that is an educated guess. Not too many companies report this coming week, of note.
Whether the S&P 500 is “cheap” or not seems to be a point of debate. While the bears continue to pound away, and say stocks are overvalued (seriously ?), an S&P 500 trading at 13(x) forward earnings which forecasts 6% year-over-year earnings growth in 2012, and 12% year-over-year earnings growth for calendar 2013, particularly with subdued company guidance since very few managements want to be aggressive with guidance in this type of environment, the S&P 500 does not look all that expensive to me on a PEG (p/e to growth rate) basis. In addition, the S&P 500 is still sporting an earnings yield of 7.5% as of Friday, September 7th, just a little lower than what was close to a record earnings yield of 8.25% on July 13th.
495 of the 500 S&P 500 companies have reported earnings for q2 ’12, thus that 1.3% growth rate wont change very much. Analysts are still locked in on the 3rd and 4th quarters, but recent price action for the major equity market indices could be telling us something pleasant this way comes (to turn a Shakespearean phrase) like upward earnings revision and better earnings growth down the road.
Remember, the stock market is a discounting mechanism, so today’s stock prices are discounting what could be expected for the 2nd quarter of 2013, withThomsonReuters currently projecting 10% earnings growth for that quarter, down from 14% on July 1.
(We’ll be back with more trading and sector commentary over the weekend.)
Trading/sector/assorted market observations:
* Intel (INTC) and FedEx (FDX) both warned this week and lowered current quarter guidance. FedEx reports on Sept 18th, before the bell, and the long-awaited restructuring of Express is expected, or at least a hint of it is expected. The fact that FDX actually rose $0.22 on the week, is another example of what we have written about previously in that companies that are warning and lowering guidance, have been met with buying. Bad news has led to higher stock prices. That is an important “tell” in my opinion. Intel didnt fare as well on the week, but it only lost a whopping $0.08 (yes, 8 cents) and fell 0.33% on the week. Hardly shades of September, 2000. We like Intel at $23 (actually under $24), which is the point of the upward sloping trendline off the March ’09 market bottom, and FDX at $85, and then again at $80. (long INTC and FDX.)
* The Treasury action on Friday, after the weak jobs number was notable for its contrarian action. I wonder when the last time was we saw Treasuries decline in price on a weak jobs number. We are maintaining our Treasury short of TBT and TBF, just like we should have maintained our Nasdaq short in the late 1990’s, and it has been a painful trade. When the Nasdaq 100 came apart in the Spring, 2000, it fell 17% that first month, per our technical software. However what I failed to recognize and eventually went into denial about was that large-cap tech stopped going up on good fundamental news, all through the late summer and fall of 2000. Was the Treasury action on Friday the first glimpse of what many think will be a painful unwinding of the interest-rate trade ? It is still too early, but if Treasuries get a beat-down on QE3 news, that would suggest to me that we are at the beginning of the end of the 30-year bond/Treasury bull market. Listen / watch for news that should be obviously bullish for Treasuries, and then if prices head south, that is your tell. (Long TBT/ more TBF).
* Another interesting stat out of Bespoke, pertaining to the previous bullet point: on Thursday afternoon Bespoke put out a research piece saying that when the stock market was up more than 1% on the day prior to the payroll report, in the last 4 instances, the S&P 500 has been down at least 60 points on a weaker-than-expected report, thus when we saw Friday’s weaker jobs number we expected the S&P 500 to get crushed. Guess what – Friday’s stock market action broke that pattern/trend. The stock market is telling us something and so far at least in June, July, and August, we like what we are hearing;
* We’ve written about it before, but we continue to watch the corporate high-yield market. The two corporate high yield ETF’s – HYG and JNK – have yet to surpass their previous highs from 2010 and 2011. JNK is still trading below its November, ’10 high over $41, and the HYG is still below its late April ’11 high near $93. Moody’s puts out a leveraged finance issue monthly covering macro high yield issues, and the credit research company thinks Europe is preventing further spread tightening her in the US. Moody’s “liquidity stress” index remains low (and thus favorable), although covenant quality worsened during August. Moody’s trailing-12-month Global speculative default rate came in at 2.8% in July, down from 2.9% in June, but higher than the 1.9% in July ’11. The US speculative-grade default rate was 3.3%. per Moody’s corporate default rates remain “low and steady”. Moody’s notes that the median yield on speculative grade issues was 6.6% in July, the lowest on record, dating back to 1991. The average monthly median yield is 9.8% per Moody’s September 5th report. I do worry that high yield is becoming a crowded trade – it is almost being used as a “go-to” asset class for those worried about duration risk and interest rates. There seems to be a lot of investor money packed into high yield today, and probably more so for investment-grade. We remain overweight high-yield in client accounts. (long HYG, JNK, Pimco’s high-yield fund, Pioneer’s high yield fund, and a host of unconstrained bond funds.)
* The majority of the S&P 500 is overbought, with the exception of utilities. AT&T and Verizon had a good week, slightly underperforming the S&P 500. Most of the names that we find as “oversold” are defensive names. We could use a good 2% – 3% correction, but we have been saying that for a few weeks.
* Ford (F) and Alcoa (AA), two of our “dirt cheap” stocks coming into 2012 had a good week. Ford announced they were going to accelerate their European lineup and that Ford was “going to target profitable growth” in Europe ( makes you wonder if they were targeting unprofitable growth previously ?), pushing the stock 9% higher on the week. Alcoa got a lift from the Chinese infrastructure announcement on Friday, sending the stock up 7.8% on the week. Alcoa is still trading at about 75% of tangible book value, while Ford took out the $10 level, which was technical resistance. (long F and AA.)
* The action in credit-card stocks is somewhat puzzling. V, AXP, MA – not trading as we had hoped with the rest of the market. V needs to take out $130 – $131 on volume. (long small position in AXP, more V.)
Thanks for stopping by.
Trinity Asset Management, Inc. by:
Brian Gilmartin, CFA
Portfolio manager