Yesterday’s 1.3% gain in the S&P 500 was certainly a head-scratcher. For the life of me I could not figure out the reason that for that sort of upward pressure right out of the gate. Was it lower oil, or the commentary out of China regarding more easing? Well, nothing new there, both have been IN the market for weeks/months. Regardless of the reason (possibly quarter end window dressing) the price action had the feel of a full blown risk-on set up, dollar strength, and weakness in gold and bonds.
I would add that there were a few stocks that did not participate in large cap tech, notably BABA, FB, INTC & MSFT, nearly $1 trillion in market cap. While AAPL’s 2.5% gains on its $735 billion in market cap more than made up for the under-performance of the prior group, I think it is important to note that AAPL will not be able to carry the tech sector in a year that is not shaping up to be a lay-up on the return front. Which speaks to keeping a close eye on market breadth as a gauge of the health of the rally. It would be a shame to see the really narrow among fewer stocks as opposed to broadening out to make new highs.
For the quarter about to end, the S&P500 has traded in a fairly wide range (7% from the Feb 2nd low to the Feb 25th high), despite only being up 1% for the period. The price action and the fact that we are basically in the middle of the 3 month range reflects the fact the corporate earnings outlook, which should be the main driver for stock prices, has been very volatile and estimates have come down massively over the last three months. Per Factset:
On December 31, the estimated earnings growth rate for Q1 2015 was 4.2%. All ten sectors have lower growth rates today (compared to December 31) due to downward revisions to earnings estimates, led by the Energy sector.
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If the index reports a year-over-year decline for the quarter, it will be the first time since Q3 2012 (-1.0%).
While many will dismiss this growth decline as largely the result of crashing energy earnings, there have been no shortage of poor results from large cap tech of late, which make up the largest weighting in the S&P500 (near 20%) as Energy’s weight is less than half of the Tech. So if there is another shoe to drop in Q2 it is the adverse effects of the strong dollar on Tech earnings, which could continue to pressure S&P earnings.
The chart below from FactSet shows the recent divergence in stock prices to expected earnings growth:
What sticks out to me is the period in late 2007 (highlighted) when the stock prices continue to move higher as earnings expectations had been coming down. What is clear is that at some point in early 2008, when estimates started to trend down (led by an implosion in financial earnings estimates) stock prices quickly followed. Is it different this time? Earnings estimates have now declined based on the popping of the energy commodity bubble, and the question you have to ask yourself is whether or not commodity can stabilize AND whether or not the dollar continues to crimp earnings from U.S. multinationals like Tech and Consumer Staples?
Obviously there’s a difference in the effects on markets when the banking system being at risk versus other sectors like energy. But there are some parallels here and it is interesting to think about the effects of the dollar and commodities for the broader market.