/perspectives/weekly-viewpoint/markets-remain-stuck-in-a-holding-pattern

Markets Remain Stuck in a Holding Pattern

The Dow Jones Industrial Average (Dow) fell 0.55%, the Wilshire 5000 Total Market IndexSM(Wilshire 5000SM) lost 0.05%, the Standard & Poor’s 500® Index (S&P 500) dipped 0.03% and the NASDAQ Composite Index (NASDAQ) rose...

May 19, 2014    |    By Mike Schwager

Performance for Week Ending 5/16/14:

The Dow Jones Industrial Average (Dow) fell 0.55%, the Wilshire 5000 Total Market IndexSM(Wilshire 5000SM) lost 0.05%, the Standard & Poor’s 500® Index (S&P 500) dipped 0.03% and the NASDAQ Composite Index (NASDAQ) rose 0.46%. Sector breadth was neutral as 5 of the S&P sector groups finished higher while 5 finished lower.

Index* Closing Price 5/16/2014 Percentage Change for Week Ending 5/16/2014 Year-to-Date Percentage Change Through 5/16/2014

Dow

16491.31

-0.55%

-0.51%

Wilshire 5000

19480.84

-0.05%

+1.18%

S&P 500

1877.86

-0.03%

+1.60%

NASDAQ

4090.59

+0.46%

-2.06%

*See below for Index Definitions
 

MARKET OBSERVATIONS: 5/12/14 - 5/16/14

The major market indices finished the week mixed as investors digested an uptick in geopolitical tensions, questioned the global economic growth outlook and mulled over a batch of spotty earnings reports.

The market is said to be a discounting mechanism that looks 6 to 12 months into the future. It appears, however, that in the current environment investors are more focused on near term risks versus positioning for intermediate to longer term opportunities. Economic growth in the U.S. remains poised to pick up smartly during the current quarter after what looks likely to be a mild contraction during Q1 (note: the final revision to Q1 GDP won’t be reported until June 25). First quarter growth was impacted by harsh weather conditions that impacted everything from home and auto sales to dining and shopping. The good thing about harsh winters is that they inevitably end and are followed by the milder spring and summer months. The lack of spending during Q1 has resulted in pent-up demand, which should be a driving force behind a solid rebound in growth during the second quarter and beyond. Consensus expectations are for Q2 GDP to rebound to 3%-plus and for a similar growth trend to continue for the remainder of the year. This “goldilocks” phase (not too hot, not too cold) should be strong enough to continue to drive labor market and earnings growth, but not too strong that the Federal Reserve would consider prematurely hiking interest rates. While the transition to better growth will be marked by fits and starts as witnessed by a handful of economic releases this week, the overall trend is expected to point higher.    

While the recent action in the market has resulted in undertones of a market top, the action seems more akin to a period of price discovery. This is a process where investors try to gauge what is already discounted in stock prices and what is likely to come to fruition in the months/quarters ahead. This process should be viewed as healthy, especially following the strong gains in 2013. Valuation concerns also remain front and center. While there are certainly segments of the market that are richly valued (biotech, internet, social media), the broader market’s P/E multiple—at under 16-times 2014 estimates—remains in line with longer-term averages. This suggests the market may be fairly valued at current levels but still well shy of valuation levels reached during the peaks of the Internet bubble (2000) and housing bubble (2007). Historically, major market tops are rarely made at fair value. In addition, looking back to large market corrections, in almost every case they were accompanied by rate hikes and/or spikes in energy prices, neither of which are currently in place.

Q1 Earnings Summary
First quarter earnings reports continue to wind down and overall results look solidly better than the consensus expectations at the start of reporting season. Through Friday, 467 members of the S&P 500 (93%) have reported quarterly results with overall earnings up by 5.3% (Note: when all is said and done, analysts are forecasting Q1 earnings growth of +5.5% which is solidly above their forecast of just 1.0% growth at the beginning of April). Of the 467 companies, 71.2% have beaten expectations while 19.8% have fallen short. The “beat” rate is solidly above the long-term average of 63%. On the sector level, Utilities and Telecom have posted the strongest results while Energy and Materials both saw modest declines. Looking forward, S&P 500 earnings growth is forecast to trend higher over the next three quarters.  According to the Bloomberg consensus, earnings are poised to grow 5.9%, 8.5%, 9.6% in the second, third and fourth quarters, respectively.

Investor Sentiment Remains Stuck in Neutral
The American Association of Individual Investors (AAII) reported that bullish sentiment in the most recent period rose to 33.1% while bearish sentiment fell to 22.6%. Interestingly, Neutral sentiment rose 44.3% - the highest reading since February 2003. The surge in Neutral sentiment suggests a high level of uncertainty in the market place as investors ponder the impact of tapering, the outlook for the economy, valuation levels, and concerns over whether companies will be able to deliver earnings growth. This also likely explains why the markets have been stuck in a “holding pattern” over the past few months.

The Week Ahead
The April Federal Open Market Committee (FOMC) minutes will be the focal point of the upcoming week as investors look to glean clues into the Federal Reserve’s (Fed) thinking on monetary policy. Home sales data (existing home sales on Thursday and new home sales on Friday) will also be watched closely for signs of a post-winter recovery. Other economic reports of interest include weekly jobless claims, the Markit manufacturing PMI, and the Chicago Fed Index. On the earnings front, 23 members of the S&P 500 will report their quarterly results. The only Dow component on the calendar is Home Depot, which reports on Tuesday. Several Fed officials will make public appearances during the week including Fed Chair Yellen who is scheduled to give the commencement speech at New York University on Wednesday. Trading is likely to taper off as the week progresses as investors head out early for the Memorial Day weekend.


Definitions

The Dow Jones Industrial Average is a price-weighted average of 30 blue-chip stocks that are generally defined as the leaders in their industry. It has been a widely followed indicator of the stock market since October 1, 1928.

Wilshire 5000 Total Market IndexSMrepresents the broadest index for the U.S. equity market, measuring the performance of all U.S. equity securities with readily available price data. The index is comprised of virtually every stock that: the firm’s headquarters are based in the U.S.; the stock is actively traded on a U.S. exchange; the stock has widely available pricing information (this disqualifies bulletin board, or over-the-counter stocks). The index is market cap weighted, meaning that the firms with the highest market value account for a larger portion of the index.

Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The NASDAQ Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The index was developed with a base level of 100 as of February 5, 1971.

American Association of Individual Investors (AAII) is a non-profit, membership-driven investor education organization. The American Association of Individual Investors (AAII) was founded in 1978 by James Cloonan. The AAII's mission is to teach individuals to manage their own portfolios and to beat average S&P 500 returns, while taking on lower-than-average levels of risk. AAII also publishes the results of its weekly investor confidence surveys that are based on its members' feelings about where the stock market is headed.

Indices do not include any expenses, fees, or sales charges, which would lower performance. Indices are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

Past performance is no guarantee of future results. Indices do not include any expenses, fees, or sales charges, which would lower performance. Indices are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

The individual companies mentioned in this piece were for informational purposes only and should not be viewed as recommendations.

The comments should not be construed as a recommendation of individual holdings or market sectors, but as an illustration of broader themes. This document contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Information in this report does not pertain to any investment product and is not a solicitation for any product. This material has been prepared using sources of information generally believed to be reliable. No representation can be made as to its accuracy.


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