2014 Better Show Money, Or Else...
With the blue chip indices at or near all-time highs and the year-to-date gain for the S&P 500 (NYSE: SPY), pushing 27 percent in 2013, it appears that many analysts are beginning to develop a severe case of acrophobia.
Everywhere one turns, questions about the sustainability of the bull market that is now either two-plus or nearly five years old abound. As such, 2014 may become the "show me" market.
It's Been All About the Fed
Throughout most of 2013, the bears have complained that the joyride to the upside has been all about the central banks of the world. The thinking has been that with the U.S. Federal Reserve and the Bank of Japan jointly pumping nearly $2 trillion a year into the system, much of that freshly minted cash has wound up in the U.S. stock market.
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The glass-is-half-empty crowd contends that without the global QE programs, the world's stock market indices wouldn't be anywhere near where they currently reside. But with the various "carry trades" and fancy strategies utilized by the big banks, institutions and hedge funds that can actually borrow at zero percent, the bears contend that free market "gravity" has been suspended.
And while the bear camp has had a rough go of it this year, they continue to believe that economic and market gravity will return at some point soon - and stock prices will be none the better for it.
It's Been All About Multiple Expansion
Another argument that has been bandied about quite a bit lately is that the robust gains seen in the U.S. stock market are largely due to "multiple expansion." In English, this means that investors are simply willing to pay more for a dollar of corporate earnings than they have in the past. And because of this expansion of Price-to-Earnings multiples, stock market valuations have become expensive.
The counter argument here is that GAAP EPS (earnings per share using generally accepted accounting principles) improved on the order of 12.5 percent this year and are projected (always a dangerous game) to grow another 11 percent next year. Therefore, one must admit that there has been at least a modest amount of organic growth mixed in with the expansion of the multiples.
But, But, But...
Because stock prices have grown faster than earnings over the past two years, valuations have moved toward the expensive zone. And while the stock market can remain "overvalued" longer than most investors imagine possible in real-time, the current trend of "multiple expansion" clearly can't continue unabated forever.
However, two of the biggest problems with playing the valuation game include the facts that (a) stock market valuation lies in the eye of the beholder and (b) there are a great many valuation indicators. Thus, unless valuations become blatantly lopsided such as they were in 2000, making short- to intermediate-term investment decisions based on valuations can be problematic.
The Bigger Problem
The bigger problem for stock market investors lies in the growth rates of the U.S. economy and corporate revenues.
Everybody on the planet knows that the economy is not exactly hitting on all cylinders at the present time. There are lots of reasons why this has been the weakest expansion in modern times. But the bottom line is GDP growth has been anemic. It makes sense then to argue that if economic growth doesn't pick up, the stellar gains in the stock market won't last.
Next up is the issue of corporate revenues. To be sure, corporate profits are at an all-time high. However, the knock on this statistic is that corporate America has largely used cost-cutting measures in order to squeeze out more profits from the current revenue stream. And since revenue growth has been underwhelming during this economic cycle, the bottom line is that revenues are going to need to grow at a faster clip if stock prices are to continue to rise.
Show Me, Or Else!
Taking stock of the current situation in the stock market, one can argue that the current bull is getting old, that valuations are becoming stretched, and that sentiment is entirely too positive. In short, such a combination has usually led to meaningful declines in the stock market.
But before you run out and start loading up on those inverse ETFs, it is important to understand that the wild card here is growth. If economic growth does perk up toward more normal levels, it would follow that revenues - and, in turn, earnings - would also improve. And if revenue growth begins to show up, it is a safe bet that stock prices will continue to rise.
So, unless another crisis emerges or the Fed decides to start tightening rates much sooner than anticipated (a highly unlikely event), the big key to the coming year will be state of growth in the economy, revenues, and corporate profits. Improved growth will be a good thing for investors while disappointment will likely be treated badly - to the tune of a 15 to 20 percent decline in stock prices.
In essence then, investors will be saying "show me the money, or else!"
Current Market Drivers
We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).
1. The State of Fed Policy
2. The Outlook for Economic Growth
3. The State of the Bull Market
The State of the Trend
We believe it is important to analyze the market using multiple time-frames. We define short-term as 3 days to 3 weeks, intermediate-term as 3 weeks to 3 months, and long-term as 3 months or more. Below are our current ratings of the three primary trends:
Short-Term Trend: Positive
(Chart below is S&P 500 daily over past 1 month)
Intermediate-Term Trend: Positive
(Chart below is S&P 500 daily over past 6 months)
Long-Term Trend: Positive
(Chart below is S&P 500 daily over past 12 months)
Key Technical Areas:
Traders as well as computerized algorithms are generally keenly aware of the important technical levels on the charts from a short-term basis. Below are the levels we deem important to watch today:
- Near-Term Support Zone(s) for S&P 500: 1800
- Near-Term Resistance Zone(s): 1808-1813
The State of the Tape
Momentum indicators are designed to tell us about the technical health of a trend - I.E. if there is any "oomph" behind the move. Below are a handful of our favorite indicators relating to the market's "mo"...
- Trend and Breadth Confirmation Indicator: Positive
- Price Thrust Indicator: Positive
- Volume Thrust Indicator: Neutral
- Breadth Thrust Indicator: Positive
- Bull/Bear Volume Relationship: Moderately Positive
- Technical Health of 100 Industry Groups: Neutral
The Early Warning Indicators
Markets travel in cycles. Thus we must constantly be on the lookout for changes in the direction of the trend. Looking at market sentiment and the overbought/sold conditions can provide "early warning signs" that a trend change may be near.
- Overbought/Oversold Condition: The S&P 500 is overbought from a short-term perspective and is overbought from an intermediate-term point of view.
- Market Sentiment: Our primary sentiment model remains Negative .
The State of the Market Environment
One of the keys to long-term success in the stock market is stay in tune with the market's "big picture" environment in terms of risk versus reward because different market environments require different investing strategies. To help us identify the current environment, we look to our longer-term State of the Markets Model. This model is designed to tell us when risk factors are high, low, or uncertain. In short, this longer-term oriented, weekly model tells us whether the odds favor the bulls, bears, or neither team.
Weekly State of the Market Model Reading: Moderately Positive
If you are looking for a disciplined, rules-based system to help guide your market exposure, check out The Daily Decision System.
Thought For The Day...
Expectations are the root of all heartache -- Shakespeare
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At StateoftheMarkets.com, our goal is to provide everything you need to be a more successful investor: The must-read headlines, market commentary, market research, stock analysis, proprietary risk management models, and most importantly – actionable portfolios with live trade alerts.
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Wishing you green screens and all the best for a great day,
David D. Moenning
Founder and Chief Investment Strategist
For up to the minute updates on the market's driving forces, Follow Me on Twitter: @StateDave (Twitter is the new Ticker Tape)
Positions in stocks mentioned: none
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