Wednesday, April 20, 2016

April Market Update

Will the S&P 500 set a new high level and surpass 2130? Last summer we experienced a major technical breakdown in the market. At the end of September the 5-month moving average was below the 12-month moving average. In September of 2015, the 10 and 12 month simple moving averages suggested investing in cash not US stocks. The market has whipsawed back and forth since the late summer sell signal. Furthermore, we are currently well into an earnings recession, defined as two quarters of negative y/y change in earnings for the companies listed in the S&P 500. So how does this end? We've had a tremendous rally since Mid-February. The folks at Hedgeye are calling this a bear market bounce. The 10 and 12 month moving averages ended March in the positive and signaled that investors exit cash and own US stocks. Momentum investing can trump fundamentals over various periods of time, but ultimately the prices of stocks reflect earnings and dividends. What is the upside and downside risk from these levels? Do we see the next 10% up from 2,130 taking the S&P 500 to 2,343. Given decelerating earnings, is a 20% correction more likely from the 2,130 level? This means the S&P needs to go down to at least 1,704. For the S&P 500 to increase to 2,343 we will need to see an expensive market become even more expensive. Click on the charts to enlarge.
Look at the Schiller P/E ratio for the S&P 500:
P/E ratio for S&P 500:
This market is expensive and makes me lean toward the correction scenario, however as long as momentum is able to supersede fundamentals we need to invest with what the market is giving us. We can look at moving averages again at the end of April to see if the momentum can continue, but remember that adding long term money to this market is an expensive proposition. The main benefit of investing in this market is that the dividend rate is currently higher than the yield on 10-year treasury bonds. Lastly for earnings to increase, revenue needs to increase. Barry James of James Investment Research recently wrote this to help us understand why revenues are not accelerating in this economy:
We have previously seen a lot of share buybacks going on as companies were trying to get more money back into the hands of their shareholders. Harvard Business Review found that from 2003 – 2012 S&P 500 companies spent 54% of their profits buying back shares. They spent another 37% paying dividends, which have not left much for trying to grow their business. Much of this can be attributed to the financial crisis and poor economic policies which discourage business risk. We cannot expect the same level of share support in the future, so stocks will remain in limbo a bit longer. However, this should be good for a return of common sense investing in smaller and more value oriented stocks.
Please consult a qualified financial advisor before making any investment decisions. This blog is for educational purposes only and does NOT constitute individual investment advice.

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