Many are calling this breakout to new highs a new bull market.While we can call it whatever we’d like, the price action we’re seeing today is nothing new.It is simply another surge higher in an on-going bull market that began in 2009.So what can we expect from this surge and what makes us nervous?
Support Should Hold
After nearly two years of a painful congestion in stock prices, the markets have finally become more constructive and more productive in terms of real returns for investors.It’s a welcome change.We’re seeing all time new highs again in a majority of indices and sectors.With our technical hats on, we can draw a few lines in the sand designating key support levels.Any pullback in the S&P 500 should hold about 2100 or 4970 on the Nasdaq Composite.Investors should be back in the buy-the-dips mode but avoid chasing short term bursts higher if possible.So far, we haven’t seen even a mild pullback making this a difficult tactic.Failure to hold above these support levels for whatever reason would be alarming, making this break out, look more like a fake out.
The Correlation Between Oil and Equities
There has been an oddly high correlation between trends in equity prices and the price of oil.While stocks and the stock market in aggregate have been very strong since the beginning of the new quarter, oil prices have been heading lower.We need to watch this carefully.The technical damage for the commodity now trading below $43 raises a bit of a warning flag for “the markets” based on the recent correlation.But, so far, the markets seem to be shrugging it off.Looking backwards, I couldn’t guess why the correlation has been so high, beyond some sense that oil prices might represent some indication of economic activity.We think that’s nonsense.When the supply of oil is 50% greater than anytime in history, as it is today, we can’t look at price the same way; as a linear function of demand coming from economic activity.Low oil prices are a bonus to consumers and tough on oil companies. So the thing to watch is not really the falling price of oil but rather the market’s reaction.I can only hope (and partially expect), the markets will break the oddly high correlation of the past 6 months.We’ll see.
Earnings and Valuations
One thing we are NOT seeing so far among 2nd quarter corporate reports, are any really robust bottom line blow out earnings.Revenues are about the same as we have seen for the last several years – modestly positive.But, one of the real changes thus far is the degree to which earnings are beating exceptionally low analyst expectations. This is a chart from Bespoke showing the percentage of companies beating earnings expectations.
Since 2011, the percentage of companies beating expectations each quarter has come in close to 60%, very consistently.Today, we’re running at 67%, indicating that analysts were just too negative going into this quarter’s reporting period.Of course that could change in the next 30 days.So, the burst higher in stocks is partially driven by upside surprises in earnings, but only relative to very negative expectations.At the same time, when we look at valuations, we see that the S&P 500 is now just more expensive than it was at the last peaks in 2014 and 2015.Unfortunately, when valuations hit these levels in the past, forward returns looking out 12-18 months have not been impressive (less than 2% annually, which is more than the current dividend on the index).So, at least from this perspective, our surge higher in prices should come with some tempered expectations in terms of duration and magnitude.
US Dollar on the Rise (Again)
A rising US dollar makes for a difficult environment for investors.Typically a rising US dollar is tough on international, income and credit holdings.Also, we need to remember that almost 50% of earnings for the mighty 500 stocks in the S&P are generated from overseas revenues.A rising US Dollar also gives the Federal Reserve more reason to raise interest rates.I think it’s safe to say that a great deal of the volatility in equities that we’ve seen in the last two years has been rooted in the 2013 rise of the US dollar and other currency trends around the world.Today, the US dollar is stable and still below the 100 level of two years ago, but the technical chart pattern indicates we could see a break out to new highs in the coming months.There is simply too much going on in global currency markets to make an accurate forecast so we can only watch and observe current price.Gold investors will want to watch this very closely as well, as a rising US dollar is the arch enemy of precious metals.We have already taken our very healthy profits on gold and will watch what happens next as the US dollar trend looks to be moving up again.
Disruptive Politics
And then there is this issue.I couldn’t guess at what might happen, or the markets’ response.I’ve been asked 1000 times and my answer is still the same… I don’t know.What I do know is that we are seeing historic lows again in daily volatility.I will be shocked if that condition persists going into the 4th quarter.We should all prepare for some wild price swings, as we get closer to the general election.This is not the time to go way out on that limb of chasing high beta stocks as you might easily find yourself selling the same names in the next few months to cut out some drama in your portfolio.I’ll repeat Buffett’s words of wisdom again.This is a time to seek out safe returns but not maximum returns.We’re on that program 100%.
That’s it for this week.I hope everyone is enjoying the summer time with friends and family.
Cheers
Sam Jones
