Weekly Update: Deep in the heart of Texas
This week, I traveled in the great state of Texas. The feeling that everything is bigger there is unavoidable. However, Austin is unique. It has hills, waters, and it’s not as big or spread out. And there is some sort of festival every week! An adviser I met there said in discussing dividends that he hasn't spoken of bonds to his clients for several years but rather "income producers.’’ I like his thinking. The big news this week came from Apple, which raised its dividend, increased its stock-buyback plan and announced a 7-for-1 split. This helped push the market past today’s Ukraine messiness, but it also illustrates a worry—the market advance has narrowed considerably, with large-weight issues such as Apple, Google and IBM driving the S&P 500’s advance even as the number of daily NYSE new highs continues to decline. Strategas Research says the year’s gain has been concentrated in just the 10 best-performing names and that there aren't many signs of internal momentum or accumulation from this current rally. In particular, the new-high data has failed to expand and at 60%, the percentage of issues above their respective 50-day moving average is still on the lighter side. Barron’s reports that while the S&P 1500 Index is just off 1.6% from its all-time high, the average stock in the S&P 1500 is now down 12.5%.
The S&P 500 has gone over 500 days since 2012’s 8% correction and has delivered a nearly 40% return since then. Thus, the likelihood of some sort of surprise pullback is lurking. There is no reliable roadmap for determining when corrections occur. Most come when investors least expect; fundamental and performance conditions have varied considerably at the start of prior corrections. For instance, P/E ratios and EPS growth have been both high and low at the start of prior corrections, while performance in between corrections has ranged from good to exceptionally strong. Neither is it uncommon for the market to go for prolonged periods between corrections, the longest being over three years. Bhirud Associates says stock market corrections, especially technical ones, can occur at the drop of a hat and don’t need many catalysts; it is the nature of the beast. We do know that, seasonally, market performance between April 30 and Oct. 31 is significantly weaker than the comparable Oct. 31 to April 30 periods. Since 1990, the S&P has averaged 1.3% for all May through October periods, compared with 7.2% for all November through April periods. This year is complicated by midterm elections where performance deteriorates even further—the S&P averages a loss of roughly 2.9% during the April to November period of these years, while seven of the 10 sectors post negative average returns. The S&P spent January-October 2004 trading in a sideways pattern, with no gain until liftoff occurred on Nov. 3, 2004 with the culmination of the presidential and congressional elections.
The Institutional Strategist says the S&P appears to be running for the 1,920 level where the chart suggests resistance will form. “Sell in May and go away” may be a good policy this year. Support is evident at the 200-day moving average of 1,772. So from the 1,892-1,920 range, where it suggests positions should be reduced, TIS sees a 7%-10% risk in the popular averages, with uneven performance among sectors. Consumer discretionary, biotechs and telecoms are starting to broadly underperform, with TIS viewing biotech as a bubble. Energy and utilities are outperforming and in energy's case, may be in for a period of extended leadership. It is noticeable that eight of the 10 IPOs in the U.S. market last week came to market below their expected price range. This is the highest number of below-range launches since 2004. Right now, the market appears to be more focused on earnings (more below) and the intentions of central bank policymakers, who keep signaling here and abroad that the spigot will remain wide open, in part on worries deflation may be the bigger concern. The head of the IMF labeled it "the ogre that must be fought decisively." An adviser in Dallas shared this long-term worry, observing deflation "has no geographic bounds.’’ It’s not an issue many are talking about. Oh, by the way, May is just about a week away.
Indicators suggest spring bounce The Conference Board gauge rose a relatively robust and slightly better than expected 0.8% in March, with improvement again driven largely by accommodative financial conditions (stock prices, interest rate spreads and the leading credit components all provided positive contributions). Employment indicators also acted as a tailwind. The Chicago Fed’s National Activity Index also was revised up sharply for February and remained well above trend in March. And ISI's proprietary trucking survey improved for a ninth consecutive week to its highest level since December 2005. Participants reported better revenue and are optimistic about the spring as demand continues to accelerate, capacity is tight and, for many, pricing is better than expected.
Durable goods suggest spring bounce March orders rose 2.6%, well above consensus, led by a 21.6% surge in volatile defense orders. However, core orders also rose a stronger than expected 2.2%. April’s Markit PMI and regional readings from the Kansas City and Richmond Feds also showed manufacturing activity expanding this month.
Reports from Europe suggest spring bounce German business confidence unexpectedly rose in April, signaling optimism that Europe’s largest economy will withstand risks from tension in Ukraine to price weakness in the eurozone. Also this week, the eurozone flash PMI rose to its highest level since May 2011, with better than expected readings in both its services and manufacturing components.
Housing woes may go beyond weather New home sales fell a much worse-than-expected 14.5% in March, with weakness in the West where the weather wasn’t bad, and mortgage purchase applications have been on a downward shift since last spring, further suggesting weather alone can’t be blamed for recent softness. The new-home sales monthly sample size is small and volatile—unadjusted sales actually fell in March vs. February for the first time in the series’ 52-year history. Zellman Associates says there’s no way builders sold less homes in March than February given February had terrible weather and March had five full weekends; its survey shows gross orders from builders rose 29%. Still, with existing home sales also slipping, housing continues to disappoint. Higher mortgage rates and worsening affordability—low inventories are putting upward pressure on new house prices, which have jumped 31% from their 2009 low—represent major headwinds. It appears uncertainty about housing’s underlying trend will remain elevated until we get more clarity in the April-May reports.
Earnings watch With nearly a quarter of S&P companies finished reporting, the Q1 earnings season is off to a slower start than at the comparable point of the Q4 2013 season, Yardeni Research says. Of the 118 companies in the S&P that have reported through yesterday, 64% have exceeded estimates and have beaten by an average of 0.7%. That's worse compared to the same time period in Q4 2013, when more companies (66%) in the S&P beat consensus earnings estimates by an average positive surprise of 2.4%. Furthermore, 53% have beat Q1 sales estimates so far by an average of 0.1%, also worse than Q4’s results of 70% and +0.9%.
China watch The HSBC/Markit Flash Manufacturing gauge represented a fourth straight month of contraction in April, though at 48.3, it also was the first uptick in four months. The internals were weak, with new export orders and employment rolling over badly. HSBC said stimulus measures seem to be having limited impact, and that perhaps more measures will have to be unveiled in the coming months. Our stronger growth scenario is predicated in part on a soft landing, i.e., annualized GDP growth around 7%, and not much worse in China.
Disruptive technologies In the West, fracking technology is changing the outlook for U.S. energy independence. Can Russia compete or even survive economically, if Brent crude trades at $90? Can the Saudis? Is a great deflation coming in terms of input costs for the manufacturing sector as a result of a fracking boom? Among other disruptive technologies, which create deflationary conditions, the Internet continues to break down pricing structures in the U.S. retail sector, The Institutional Strategist says. It expects a number of small shopping malls to lose many of their lessors this year. King Securities notes retail stores are closing at their highest pace since Lehman’s collapse, and it’s not just distressed chains such as Radio Shack and bankruptcies, which are at a 3-year high. These closures represent only 34% of the total square footage taken out of the market.
Not all Sunbelt cities are growing The nation’s two fastest-shrinking cities from 2010 through 2013 were Pine Bluff, Ark., and Farmington, N.M., down 4.43% and 2.72%, respectively, according to Census Bureau estimates. At 2.45%, Snowbelt stalwart Flint, Mich., suffered the third-largest percentage loss, continuing a prolonged decline that began in the 1960s as the auto industry began to downsize and shift southward. Overall, it’s estimated the U.S. population grew 2.4% over the past three years.
Cowbirds and cattle As we drove from Austin to Houston this week, there was not much interesting scenery other than the beautiful bluebonnet, which is the state flower. We passed several ranches where cows and longhorns were grazing, in many cases with egrets (called “cowbirds” by the locals) walking alongside them. Why cowbirds? They eat the bugs annoying the cows. Along the route, we also passed a truck with a huge animal trailer attached, filled with cows who seemed to be enjoying the "ride." They don't appear to know that there's big trouble when they get to their destination. As a lover of filet mignon, I had to look away!