I took some time off at the end of last week -- three days to be exact -- for a family vacation. It wasn't a long time to be gone, but nevertheless, it felt like a lot had changed when I returned.
In an effort to get caught up, I learned that Europe is the new hot spot of relative investment strength; that China is back on an accelerating growth path; and that a correction in the US stock market is upon us after the S&P 500 suffered its biggest weekly decline in nearly two months.
One is free to agree, or disagree, with any of those ideas. Those are simply the impressions that formed in my mind after reading an assemblage of views from the market punditry.
What struck me most, however, was how cautious-sounding the commentary had gotten with respect to the near-term outlook for the US stock market. In some respects, what I heard followed form with the views we expressed in mid-June when we downgraded our market view to neutral. We said then that we thought it was advisable to harvest some profits from the rally that began in mid-November.
The market of course humbled us in its inimitable way and increased another 5.0% from our mid-June post, yet the basis for our view remains intact and we are sticking to it.
- Valuation isn't as attractive as it once was
- Monetary policy isn't as impactful as it once was
- Earnings growth isn't as strong as it once was; and
- The market is grappling with the idea of quantitative easing being dialed back (perhaps too soon)
A popular refrain I heard from the talking heads on TV is that the downside risk in the near term outweighs the upside potential. That's not exactly stepping out on an analytical limb considering the S&P 500 recently completed a six-week run in which it gained nearly 10%. Sometimes, though, there's just no way around stating the obvious.
On that note, I wanted to briefly highlight for you this week some of the popular thoughts I came across that address why the stock market is believed to be vulnerable in the near term.
Eight Is Enough
- The ratio of the S&P 500 market capitalization to real GDP is nearly 1-to-1, which puts it in a territory that has been associated with prior market tops.
- Price targets set by strategists for this year (and next year in some cases) have already been met, suggesting a more cautious stance might now be taken given the market's fair valuation.
- The multiple expansion phase has run its course. The next leg higher will need stronger earnings growth and that's not a given with interest rates rising and profit margins already near record levels.
- The bull market, in its 53rd month, is at, or near, the end stage (the average length of a bull market since 1962 has been 48 months, according to Birinyi & Associates).
- We're entering a period of heightened uncertainty
--It is unknown who the next Fed chairman will be and the nomination must be made soon
--German Chancellor Angela Merkel faces an election in September
--Congress faces the task of striking a budget agreement by October 1
--The online health exchanges created under Obamacare need to be operational by October 1
--Congress will have to tackle raising the debt ceiling
- Statistically, September is the worst month of the year for the major averages (according to the Stock Trader's Almanac, the average change in the S&P 500 in September since 1950 is -0.6%)
- The increasing use of margin debt is increasing the risk profile of the stock market given the potential for forced liquidation in the event of an exogenous shock or sudden shift in investor sentiment
- With economic data sending mixed messages on the state of the US economy, and overall growth still relatively low, the stock market will have difficulty handling a tapering announcement in September
What It All Means
The tone in the pundit community has grown more cautious, yet it remains a long way from bearish. There are a lot of recommendations right now to take some profits and then buy again on the expected weakness.
No one of course knows for certain what the future holds, so it is somewhat trite to suggest so insouciantly to buy on weakness. That doesn't mean anything without an awareness of the context in which the market has gotten weaker. Right now, it is basically a recommendation that presumes things will continue like they have for the last 53 months.
Admittedly, they could. But, with the uncertainty lingering about the Fed's commitment to quantitative easing and the leadership complexion of the Fed itself, Congress back in the mix as a market mover, interest rates rising, and industry leaders like Cisco (CSCO) and Wal-Mart (WMT) bemoaning the challenging business environment, there is a reasonable chance the stock market won't be driving on cruise control the rest of the year.
We'd stick with systematic investment plans, but like we said in mid-June, we'd advise taking some profits from big gainers and sit in neutral mode for the time being.
There are always opportunities to buy on weakness. Don't forget, however, that there can be a large opportunity cost for buying on weakness too soon in a changing environment. By way of example, the Market Vectors ETF Trust Gold Miners ETF (GDX) has spiked roughly 40% off its low in the last two months. That's a huge move. Even so, the problem for many who bought on weakness is that the GDX is still down 45% from its September 2012 peak.
The times, they are a changin'. Having a proper sense of context in a changing environment matters greatly for your entry points and the time it may take to profit from buying on weakness.
--Patrick J. O'Hare, Briefing.com