More of the same?

As we conclude an interesting week in the market, we will point out that so far, this year has some resemblance to what happened in the beginning of last year. The stock market began both years in a steady uptrend. 2010 slipped a little in late January and early Feb with about a 10% correction, but then went on to rally for two months straight, (up to the late April highs). From that point on in 2010, we saw a lot of “chop” in the market through the summer until September when energy stocks finally pulled the market into the next leg up after August and through the rest of the year. This year, the uptrend continued straight though until mid-February, before slipping from roughly 1340 to 1250 on the S&P. The earthquake in Japan was part to blame for this. Since then, we have seen decent earnings reports accompanied with some very disappointing macro-economic data. The housing market took another step back and further dragged on hopes for better US GDP Growth. At the same time, unemployment data came in weaker than expected. The Greece/European debt turmoil hasn’t helped things either. Then just out this morning, orders for U.S.-made durable goods partially rebounded in May after a steep decline in April. Durable-goods orders rose 1.9% in May after a downwardly revised 2.7% fall in April. The increase in May was slightly stronger than expected. Transportation orders had the biggest increase last month. Excluding transportation, orders rose 0.6%. Shipments rose 0.3% in May. Orders for core capital goods rose 1.6% in May after a 0.8% fall in April. Could it be that we are in for some more of the same “chop” through the summer? Hard to tell at this point, but so far it looks like things are shaping up that way.

Jan-Jun 2010


Jan -June 2011

Earnings Estimates Remain Intact

While continued concern in the Middle East, worries over debt crisis in Greece and greater Europe, and underwhelming economic numbers are giving investors cause for concern, it is important, from time to time, to take a step back from the news headlines.  Ultimately, the markets, both foreign and domestic, will follow the trend of corporate earnings.  If earnings are growing, markets tend to rise over time.  If earnings are declining, markets tends to fall over time.  Also, markets tend to discount future earnings by either moving up or down in anticipation of what may happen.  Therefore, we want to periodically review earnings to see if earnings estimates are being adjusted upward or downward by analysts who follow the companies.  Of course, analysts tend to often be late in making adjustments either up or down, so what we really want to follow is the trend of earnings estimates - are they trending higher, trending lower, or staying roughly the same.

Given the domestic markets have declined since the beginning of May, we would expect to see earnings estimates start to trend downward over the past month and moving forward. Let's take a look at earnings estimates for the S&P 500 as a whole and broken out by sector since the end of last quarter.  The aggregate top line number (first line) doesn't equal the total of the numbers below that number because companies can be in multiple sectors.
 

		1-Jun		1-May		1-Apr
S&P 500		97.88		97.21		96.99
S&P 500 Consumer Discretionary (Sector)		20.48		20.31		20.10
S&P 500 Consumer Staples (Sector)		21.53		21.43		21.30
S&P 500 Energy (Sector)		48.78		43.05		43.04
S&P 500 Financials (Sector)		16.65		17.73		18.21
S&P 500 Health Care (Sector)		32.47		32.92		32.77
S&P 500 Industrials (Sector)		20.87		20.83		20.52
S&P 500 Information Technology (Sector)		30.90		31.10		30.65
S&P 500 Materials (Sector)		17.89		17.33		16.92
S&P 500 Telecommunication Services (Sector)		7.81		7.69		7.75
S&P 500 Utilities (Sector)		12.78		12.86		12.85

 As you can see with the list above, with the exception of Financials most sectors have seen earnings estimates increase since last quarter or in some cases, like utilities and healthcare, revised slightly lower.  As of June 1st, only a few sectors have seen a decrease from May 1st estimates.  So while the markets have declined, earnings have not in aggregate.  The overall number for the S&P 500 (top line) has continued to move higher for 2011 and also 2012 (estimates not shown but currently stand at $111.82 for the index, up from $110.29 in April). 

If estimates trend lower in the coming weeks, the recent downturn in the markets is most likely adjusting to the probability of slower earnings growth this year and that adjustment would be considered normal.  However, if estimates continue to stay roughly the same and not trend lower (which we believe is likely), we could have a divergence from market expectations and actual earnings, which could send the markets into undervalued territory and create opportunities in certain sectors.  Earnings will be the key focus in the weeks ahead, especially in July when actual earnings for the second quarter are released.

Smart Money More Confident

We haven't looked at sentiment data since earlier this year when dumb money sentiment was very high and smart money sentiment was low.  At that time we said the risk/reward setup was not favorable based on historical precedent.  

The most recent sentiment data from our friend Jason Goepfert at SentimenTrader.com shows just the opposite occurring today. The smart money is becoming more confident as the market moves lower while dumb money is becoming less confident.   

While markets can continue to move lower in the near term, when smart money confidence rises close to or above 70 (which it rarely does), the risk/reward setup is extremely favorable for investors in the short to intermediate term.  And of course, one wants to act in concert with smart money investors, even when emotionally it doesn't "feel" right.  We believe more downside action in the indices, coupled with higher smart money confidence readings will likely provide solid, low risk, opportunities.

Weekly Update

This week's update is courtesy of our friends at Oscar Grouss Management.


"Our contention that the second leg of the corrective phase is underway certainly looks to be more reasonable after a very ugly session on Wednesday took the SPX index back down to key short term support. As we had explained, the combination of month end allocations and a late Memorial Day holiday were likely to obscure matters for a period of time but a very poor start to the May data cycle saw confidence crack in the US equity market and the largest one day decline recorded since the start of the strong rally last August.

As has been the case for several weeks, the brunt of the sell off was borne by financial stocks. It is our belief that these losses will not be quickly recovered and that large cap financials are being re-rated following an appreciation that recent legislative changes are likely to meaningfully downgrade their profitability going forward. This is particularly true of large, diversified institutions that have mixed principal and customer businesses under one conflict-ridden roof.

These we expect to see centered on the financial and commodity related sectors in the US and the emerging market complex outside. We would also be concerned about any individual issues that have become particularly linked with emerging market growth.

Within the core US equity market we still expect losses to be relatively contained and it is quite possible that the low point will be at or above that reached in mid March when the SPX traded just below 1250. A breach of this level would imply a deeper corrective move (1180 being the next clear support level) but as we always say, the least important number in a corrective move is its low point, the most important is the probability that the losses incurred will be recovered reasonably quickly. It is really this understanding that leads us to be patient with US equity exposure as opposed to emerging markets that we believe may be tracing out a terminal top to their ten year economic cycle. It should therefore be noted that the end of May saw much less sign of investor flows into the emerging market equity complex than recent months.

May’s overall losses were trimmed but this remains a very challenging start to 2011 for most equity markets. However, thus far investors seem to merely be switching their attention from equity to corporate credit. This is important since it has neutralized the effect of equity outflows on the currencies of many emerging markets. We doubt whether this balancing act will be able to stay in place much longer, and would look for one or more emerging market currencies (our favorite candidate being the Turkish Lira) to break down during the current cycle.

We would also expect to see continued strength for both US treasuries and the US Dollar. The former area is starting to look a little expensive, with the 10 year yield now well below 3.00%, but we would be patient with any long positions for the time being. As we have seen before, long dated treasury yields can fall well below any fundamentally justified level in a corrective move and both the 10 and 30 year yield would seem to have further to run. The US Dollar on the other hand continues to look remarkably cheap. At the very least the DXY (dollar index) should be able to rally up to its declining 200 day ma (77.87) with a more ambitious target being the December 2010 high just above 81."