(FH) Market Commentary - June 18
By Mary Redmond
The four-week period before the end of a quarter is the time during which most companies will release news about the earnings to be released at the end of the quarter. In the last several quarters, this has become a perilous time for shareholders of individual stocks, as earnings warnings have had the potential to slice billions from companies’ market capitalization in seconds. This fear of earnings warnings is one of the primary reasons we have been experiencing comparatively light volume on the Nasdaq and the NYSE.
Everyone has been hearing the expression “don’t fight the Fed”, but this gives little consolation to shareholders when their companies’ warn they will miss their estimates.
This week Nokia, JDSU, NT and IRF were among the high profile technology companies who warned that their sales growth would be lower than previously expected. And their warnings spilled over to the other technology sectors.
The big news of the week was the possibility of the GE– Honeywell merger being stopped by the EU. This could be an unprecedented situation, and investors have speculated that a rejection of the merger could lead to increases in trade wars between the US and Europe. The EU is clearly sending a signal that they are a force to be reckoned with. Perhaps the biggest impact was felt in the fact that this increased the levels of investor fear, as measured by the put/call ratio and the volatility indicators. This is probably attributed to the fact that any uncertainty can temporarily frighten people out of the market.
Several economic reports were also released, including the CPI, the PPI, the Fed’s Beige Book, and the Retail Sales report. The PPI and CPI confirmed that inflationary tendencies are, for the most part, contained, which leaves the Fed free to cut interest rates aggressively when they meet at the end of June.
The Beige Book, the retail sales, and business inventories confirm that we are currently in the trough of a business cycle measured by growth in the GDP. Analysts have debated as to whether we will see a U shaped recovery, or an L shaped recovery. A U shaped recovery may be unlikely, as this would imply that the rate of GDP growth could increase to levels we saw last year. Nonetheless, an increase in GDP growth from the current levels of just over 1% to a level of 2 or 3% could have a dramatic impact on the market.
This appears to many to be an unprecedented situation, as we have never had this dramatic a slowdown in the rate of GDP growth in history. In addition, late fall of 1999 we experienced an unprecedented level of capital spending on technology equipment, as companies prepared for the alleged Y2K crisis which never materialized. We many never go back to this level of capital spending again, even if the economy improves.
However, the real issue to investors remains the extent to which this will further impact the stock market.
Interestingly, if you compare statistics for the last decade, the performance of the broad market averages has been the strongest following a period in which the business cycle has been in a trough. In fact, over the last fifty years, the S & P 500 index has been 23% higher 12 months after each time the GDP dropped below 2%.
It is informative to examine the composite weighting of the S & P 500 to determine which sectors have the most influence. The following are the sector weightings of the S & P as of March 2001
Financial 17%
Technology 18%
Health care 13%
Trasportation 1%
Utilities 4%
Basic Materials 3%
Capital Goods 9%
Communications Services 6%
Consumer Cyclicals 9%
Consumer Staples 13%
Energy 7%
Clearly, the financial, technology and health care sectors have the highest weighting in the indexes, as together this triplet comprises over 50% of the S & P 500.
Several sectors have been outperforming the major market indexes over the last few weeks. In addition, we can take a look at which sectors tend to lead the market following a series of Fed rate cuts.
In the 12-month periods following the 1995 and 1998 rate cuts by the Fed, the top five performing sectors were computer software, retail, health care, and electronics. The worst performing sectors were steel, managed care, construction, and trucking. There may have been other factors to consider when evaluating these sectors, including the collapse of the steel sector. However, the “old economy” stocks, which are generally regarded to be defensive, have not historically performed well following a rate easing cycle.
Liquidity is one of the key drivers of market growth. An examination of the flows of cash into equity funds and money market funds can also illuminate the level of bullishness or bearishness among the public.
Specifically, the four-week moving average of cash to equity funds is highly correlated to the performance of the Dow and the S & P 500. While equity funds suffered redemptions during February and March, the four-week moving average of cash to equity funds is currently positive in the range of $4 billion.
While some market watchers have stated that it seems people are selling their stocks to pay for their living expenses, an examination of money fund flows indicates this is unlikely. The Investment Company Institute has reported that money market funds have taken in over $164.944 billion so far this year, which works out to approximately $35 billion per month, bringing the total to over $2 trillion. This does not even include the trillions held in savings accounts, CDs and government bonds.
In addition, most Americans have a larger percentage of their net worth as equity in their homes than they do in the stock market. The vast majority of mutual fund shareholders and stock holders have a large percentage of their holdings in retirement accounts. The tax consequences of early withdrawal from retirement accounts act as a deterrent.
A case could be made that excessive bearishness among individual investors has historically signified a major turning point in the market. When people are contributing more money to money market funds than they are to stock funds this signals a high level of bearishiness.
We also need to pay attention to the levels of issuance of IPOs and corporate debt. While demand for IPOs can be indicative of institutional bullishness, a very heavy IPO schedule can drain liquidity from the market. This week, the widely touted IPO of Kraft hit the market in an oversubscribed IPO which raised over $8 billion. The demand for this issue was perceived to be a sign of institutional bullishness.
It appeared that the Nasdaq had formed a head and shoulders chart pattern , however this pattern was rejected this week, as the index was able to rebound from the important support level of 2000. The sell off in the Nasdaq, which occurred this week took the Nasdaq trin to 4.3, a very high level which indicates a highly oversold market.
The dow is encountering resistance at 11,400, and support at 10800. A drop below 10700 would be a very bearish sign, and could cast a pall on the entire market. Yet, the trin.ny indicates that the NY stock exchange stocks are highly oversold
The markets will be hearing a lot of news in the next few weeks, as the Federal Reserve meets on June 26, and analysts will start speculating as to the probability of the Fed cutting by 25 or 50 basis points. After that, attention will immediately turn to earnings, which will start to be released the second week in July.
Investors will be paying keen attention not just to the actual earnings, but to forward guidance. |
