The acceleration in equities into year-end continues. The S&P 500 is dancing around 1,800. The Nasdaq, more rarely in sight of millennial markers, is approaching and retreating from 4,000. The DJIA conquered 16,000, for now.
Major indexes typically dance the minuet at these key psychological levels. The index level approaches and retreats from the touchstone with almost predictable precision. Usually, the century or millennial marker is not definitively crossed until the second or third time across the line.
We have not seen any change in this approach-and-retreat pattern. What has changed is the rapidity with which these markers are falling. In 2011, the S&P 500 took out 1,300; and in 2012 it claimed 1,400. In 2013 year to date, the S&P 500 has already conquered 1,500, 1600, and 1700, and has now posted closes above 1,800.
All that is Frothy …
In this environment, where investors are cheering new highs with little thought to risks in the market, the question is not whether investors are complacent, but when does complacency translate into an overextended and even dangerous market? The VIX, briefly touched 12.0 on 11/15/13, which is its low for the fall - though not quite its low for the year; the VIX briefly dipped under 12 in mid-March 2013. The 200-day trend line on the VIX opened the year above 17 and is now barely above 14.
As complacency reigns, fear retreats. A useful measure of fear is the price of gold. The GLD SPDR is down 23% year to date. The VIX, down 18% year to date as of mid-November, is roughly tracking GLD.
How low is too low? Historical lows in the VIX were reached in late 2006 and early 2007 - not comforting when you consider that the seeds of the market collapse had already been sown by that period. For right now, however, investors are just waiting to cheer the next century or millennial marker to fall.
Sinking VIX, plunging gold prices, century markers falling like tenpins - these are certainly some of the hallmarks of a frothy market. Bulls will point out that the advance is broad, and we can hardly argue with that. In our sector tracker, the spread in 4Q13 performance is fairly tight between the best sector (healthcare, up 8% in 4Q) and the worst sector (Utilities, up 5%). Very frothy markets are thin and sometimes single-sector-driven.
… Coalesces into Something Solid
So which is it? The only way this market can avoid the froth designation is for earnings to keep growing. Yes, there is a QE component in this bull market. But there is a also a good correlation between the S&P 500 move off its low and the rise in S&P 500 earnings. Between the March 2009 low of 676 and the 1,800 level, the S&P 500 has risen 165%. Earnings are on track to grow 145% from the low of $50 in 2008 to our 2014 forecast of $122 in S&P earnings from continuing operations.
To get to our 2014 EPS target will require high-single-digit to low-double-digit growth off 2013 EPS, which we expect to come in around 1110-$111. Argus Chief Investment Strategist Peter Canelo is targeting 8%-11% annual EPS growth in each of the next four quarters. Underpinning this growth outlook is continued U.S. GDP growth, with the consumer in the lead; a stable Europe tipping over into modest recovery; and a rebound from Asia's "quiet period."
We begin as always with U.S. trends, given that the U.S. continues to contribute over 60% of revenue and (depending on which regions are up and down) 50%-to-70% of S&P 500 earnings. Trends in the U.S. economy, while generally positive, have shown signs both of growth "exhaustion" after several years of expansion in the consumer economy, and the negative impact of the government shutdown on consumer confidence.
November data releases, primarily reflecting September and October data (and in some cases delayed by the shutdown), began with signs of cooling in housing activity. Existing home sales for September fell for the first time in three months, crimped by rising prices and higher mortgage rates. Then October existing sales fell 3.2% to a SAAR of 5.12 million units, the lowest level in four months.
Though existing home sales slipped 1.9% from August and then 3.2% from September, keep in mind that the August SAAR of 5.39 million was the strongest since 2009, according to the National Association of Realtors. Yes, rising rates and sinking confidence are real issues. But supply-demand may be the bigger issue. The inventory of available houses remains low. And, with housing prices rising at about a 13% annual rate, the inventory of houses selling for less than $100,000 is particularly scant.
Despite near-term dislocations from rising rates, tapering fears, and the relatively quick rise in prices, the housing industry - usually about 5% of the economy, peaking at a dangerous 6% in 2006 - is still only 3% of the economy as of 3Q13. Demographics, immigration, and catch-up in household formation all favor long-term expansion in housing activity.
The two data points flashing an "all's well" signal on the economy were the 2.8% rise in (advance) GDP for 3Q13 and the addition of 204,000 workers in the October nonfarm payrolls report. Both data points came in ahead of expectations. Bears growled that GDP growth was inflated by inventory accumulation which added half-a-point to GDP. But Chief Investment Strategist Canelo points out that the inventory to sales (I/S) ratio is well-contained by rising sales. Indeed, mid-November data shows that the three-month rolling I/S average of 1.18 is below the spring 2013 level of 1.21.
Less publicized but equally positive was the above-consensus 0.3% rise in the Index of Leading Indicators (LEI) for September. Seven of 10 components of the LEI rose, led by stock prices and the widening gap between short- and long-term rates. Within this report from the Conference Board, the 3-to-6-month outlook is accelerating, showing that business people, investors and consumers were all looking past the coming shutdown.
Consumers and business owners were more concerned about the government shutdown than grandstanding politicians. University of Michigan Consumer Confidence dipped to 72.0 in November from 73.2 in October. The NFIB's Small Business Optimism Index fell to 91.6 in October from 93.9 in September. And November consumer confidence hit a seven month low at 70.4, seemingly miles below the sunny 80.2 reading in September.
Growing concerns about government ineptitude and irresponsibility may have contributed to a cooling in consumer spending, which grew at a 0.2% rate in September after rising 0.3% in August. But with government back in (dysfunctional) action, October consumer spending jumped a surprising 0.4%.
Also in a positive offset, Consumer Incomes rose in September by 0.5% after rising by that amount in August. In October, real disposable income rose 1.3% year-over-year - the best annual income trend in four years
The gap between spending and incomes allowed the savings rate to rise to 4.9% in October, its highest level of the year. The consumer-led recovery has been lacking wage growth. As "Now Hiring" signs tacked in shop windows siphon off lower-skilled workers, higher-skill workers may finally be able to command higher wages.
Conclusion
Keeping S&P 500 earnings growth moving forward requires "all-hands-on-deck." U.S. growth alone cannot carry index earnings. We will be monitoring overseas indicators for signs of growth.
A stoppage in earnings growth will mean that the bull's days are numbered (though we do not recommend market-timing). Even so, the stock market may not in danger of imminent reversal. If EPS growth stalls, you can start thinking about putting rolling stops (triggered by a specified decline off peak of, say, 8% or 10%) on your most appreciated and/or speculative positions.
At the same time, we do not recommend jumping off this freight train. Keep in mind that the best money is often made at the beginning (institutional counter-market rebalancing) and end (retail momentum) of bull markets.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. (More...)
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