While our market indicators remain mildly bullish, our liquidity indicator took a dive into negative territory as domestic mergers and acquisitions dried up in April while the IPO spigot was ratcheted 180 degrees full on. In May, we anticipate that a $100 billion record Facebook (FB) elephant will make its plunge into the pool. This will make a splash with those lucky enough to participate at the offering price; others will be left in the wake of a likely 5 to 10 percent market correction.
MARKET SENTIMENT INDICATORS: Positive
After nearly two months of grinding and sideways actions, sentiment indicators have turned positive. Sell in May and go away this is been the order of the day for the last two years. It appears that many participants are expecting a three peat. Put to call ratios are bullish both for individual stocks and for the market indices due to negative seasonal expectations. Spreads between high grade and medium grade corporate bonds are relatively wide generating a low confidence ratio; short interest levels remain bullishly high. Finally only 31 percent of market participants in pundits are bullish, good sign for the market.
TECHNICAL INDICATORS: Neutral
After nearly two months of consolidation in the market indices the market appears prone to a correction from a technical perspective. Short term selling volume indicators have been higher on the down days lately. This negative short term trend is confirmed by the 10 day up/down volume moving averages trending below 1.0 on slightly higher volume on both NYSE and NASDAQ exchanges. Our daily trading indicators are also slightly negative evidenced by the short term MACD, RSI index and on balance volume indicators drifting into negative territory. However, we believe the intermediate technical underpinnings of the market are positive. All major market indices remain comfortably above their 200 day moving averages. The tell-tale sign for the short term may be that the NYSE composite index is still below its 50 day moving average. During the recent consolidation the breadth of the market has remained. Positive. Thus we remain constructive on the intermediate picture of the market but feel near term risk is higher than earlier in the year.
VALUATION INDICATORS: Neutral
The S&P 500 appears to be attractive on a relative basis when compared to Corporate High grade bonds and money market funds. Here equities provide a” real” current earnings yield of 3.7percent vs.1.4for A- rated corporates and – 2.3percent after inflation. Equities as measured by the S&P500 are trading at 16x TTM, close to its historical average. Total domestic market cap is approximately 1.08x GDP, close to long term historical averages. While on an absolute basis, ex-financials, the market currently trades at a 6percent discount to replacement cost/ values. This is reasonable but not “cheap”. Our DCF model forecasts the S&P 500 to trade at an 8percent discount to fair value. Considering the prospects of a 10percent total return vs. fixed income alternatives and money markets, the market is an attractive alternative.
EARNINGS MOMENTUM: Negative
With roughly half of S&P 500 companies reporting. EPS news is much better than expected with 75 percent of reporting companies beating their estimate which is slightly above the historical average of 65percent. Clearly, the impact of Europe has been over estimated by analyst’s forecasts as actual Q1 EPS has shown 7 percent EPS growth vs. -0.8 percent expected. For this quarter. This has lifted revisions to neutral territory of 1.1 positive to negative for 2012. The revision ratio for 2013 is now a positive barely 1.3- 1. However, guidance for Q2 has been uninspiring at 0.9-1. Q 2 guidance is being overshadowed by a better than expected Q1 and rising estimates for Q3 & $ 2012. When coupled with reasonable valuations and lack of competition from other asset classes, disappointments are being rather easily absorbed at the moment.
ECONOMIC & SECTOR PERFORMANCE
Most economic series are showing positive momentum. Most stunningly are the housing indicators, showing the home price index are up 2.5 percent with new home sales up 11.3 percent y/y. Consumers continue to be frugal and pay down debt. National income is up 2.1 percent while personal consumption is up a lesser 1.6 percent. Household have reduced debt levels for the third year in a row, albeit at a lower rate0.9 percent rate in 2011. In summary, there appears to be strong support for the arguments that the economy is starting to grow out of the shadows of the great recession of 2007 -2010.
The Fed and corporations have been supporting the bull market and the economic recovery. Consumers have been conspicuously absent. From 2007 to 2011.
- We find the following data revealing. ( 2007-2011)
- National income growth + 9.8 percent
- Corporate profits +29percent
- Federal government debt + 106 percent
- Capital expenditures - 7 percent
- Net issuance of corporate equities - $100 billion.
During this very fragile economic recovery, U.S. corporations have become more efficient in generating a higher return on assets. They have accomplished this with existing technological and minor upgrades coupled with a heavy dose of financial engineering via merger and acquisition and share repurchases. Net profit margins are showing signs of peaking at current record levels.
Thus, we appear to be at a critical stage of transition. Corporations need to pass the baton the individuals who have reduced their equity holdings by15 percent, have experienced a further 15 percent decline in private business valuations and 38 percent decline in real estate household valuations. Will the recent rise in “ animal spirits” result in continued and perhaps stronger employment gains? Will the individual investor return to the U.S. equities market? Is the increase in unemployment secular after what looks to be another “ jobless” recovery? Will U.S. corporations need to continue to engage in Neo-Imperialism to sustain growth?
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