The S&P 500 started off 2014 grinding sideways and then sold off hard in late January, dropping -6% or more than -100 points in seven short trading sessions. The decline was fast and furious with the ensuing rally snapping back to new all-time highs that were printed in today’s session. The Nasdaq 100 also hit new highs but the Dow and Russell 2000 remain below there recent highs from January. Without all indices participating the warning signs are flashing.
Considering the economic data points and continued Fed tapering of asset purchases the rally back to new highs is somewhat surprising. Emerging markets were slammed early in the year due to fears that the Fed’s exit from record level stimulus programs will hurt EM currencies and lead to capital withdrawals. They have not yet fully recovered and I believe are presenting some compelling long-term investment opportunities (3 to 5 years++).
Market participants appear to be confused. On one hand they are fleeing foreign markets (especially EM’s) and on the other they want the perceived “safety” of developed markets (like US markets). While this in theory sounds logical, the fact is global markets are more interconnected now than they have ever been in the past. In fact, according to Standard & Poor’s in 2012 46.5% of the total revenue from S&P 500 companies was generated outside the US. This lends to the theory that one market can’t thrive without the other and eventually will be highly correlated.
Let’s consider the facts… it has been an ugly month for economic data…
- Existing Home sales for January declined -5.1% from the December level and the same amount below January 2013 levels. The headline number at the pace of 4.62 million units on an annualized basis was the slowest sales rate since July 2012.
- The number of first time home buyers declined from the normal average of 40% to 26% and the lowest level on record. This is likely from home prices surging over the past 12 months, an uptick in interest rates, and higher healthcare premiums.
- Housing starts declined -16% to 880,000 compared to estimates for 950,000.
- Mortgage applications fell -4.1% with the purchase index at the lowest level since September 2011.
- Homebuilder confidence fell from 56 to 46 and the lowest reading since May 2013.
- Industrial production fell -0.3% compared to estimates for a gain of +0.4%.
- Retail sales fell -0.4% compared to estimates for a +0.1% gain.
- Factory orders declined -1.5% compared to a gain of +1.8% in the prior month and expectations for a +0.7% gain.
- Construction spending fell from +1.0% to +0.1%.
- The pace of auto sales declined from 15.4 million to 15.2 million compared to estimates for 15.7 million.
- Nonfarm payrolls for January came in at a gain of +113,000 compared to estimates for +175,000. December’s number was even worse.
- The New York manufacturing survey dropped from 12.5 to 4.5 compared to estimates for 11.0.
- The Dallas manufacturing index almost fell into contraction at 0.30 compared to estimates of 3.00.
- The Chicago Fed National Activity Index (a weighted average of 85 indicators of national economic activity) fell further into contraction at -0.39 in January, down from -0.03 in December, and missing estimates of -0.20. Typical readings range from -0.70 to +0.70. According to the Chicago Fed if the index falls below -0.70 there is an increasing likelihood the economy is entering a recession. Watch the -0.70 level for clues!
On tap later in the week we’ll hear from the Richmond and Kansas City manufacturing regions and then get the China PMI data over the weekend. How much longer can the market ignore the data? Nobody knows for sure but when the music stops we do not want to be stuck without a chair.
Also, consider the Q1 earnings cycle which is just about complete. It has been littered with upside and downside surprises and investors need to consider current valuations. According to FactSet…
- The forward P/E Ratio of the S&P 500 now stands 15.2, which is above the 10-Year Average of 13.9.
- There has been a High Percentage (82%) of Negative Guidance… 92 companies in the index have issued EPS guidance for the first quarter. Of these 92 companies, 75 have issued negative EPS guidance and 17 have issued positive EPS guidance.
What about the other 400 companies that have not issued guidance? If the negative guidance at 82% provides any clues Q1 earnings are going to slow. Nonetheless, current estimates for Q1 earnings in the S&P 500 are $121.41. At the 10-year average forward P/E ratio of 13.9 the S&P 500 should be priced at 1,688, more than -10% lower than today’s closing price.
Technically, the damage was erased from the recent decline within the bull market but for the uptrend to continue buyers need to step into the market now. The 1,815 price level is the first important support line that must hold, then 1,795. A move below these two levels would be a huge warning signal that lower prices are coming. Immediate obstacles/resistance registers at today’s highs of 1858/1860 and then uptrend resistance at 1885/1890.
How many buyers are left? Perhaps enough to keep pushing prices higher but don’t get caught standing when the music stops.
Does this sound like a raging bull market that can keep going higher at its current pace, or one that may be putting on some finishing touches before taking a break?