A Lump of Coal for Investors

11/29/2012 9:15 am EST


Jack Adamo

Editor, Jack Adamo's Insiders Plus

This winter will be one of discontent for most investors if they're on the long side of this market, since most indicators are pointing down for now and the near future, warns Jack Adamo in Insiders Plus.

Here's my take on what lies ahead for the immediate future: Although we may see an occasional reflex rally like last Monday's, the current slide will probably continue at least into the first week of December. That's when tax selling would normally let up. However, with the change in tax laws on capital gains, it could extend later into December.

Beyond that, the market's action will depend on early whispers about Q4 earnings, and whether there are signs of any real progress in the political stalemate. A recession and full-blown bear market are both real possibilities. Here are a few reasons I believe that.

For the last few quarters, the slow growth in corporate earnings has come mostly from cost-cutting (layoffs, idling plants, etc.). Revenue growth has been virtually nonexistent.

In fact, if you look at GAAP earnings (Generally Accepted Accounting Principles), which don't exclude all the alleged "one-time" costs that somehow occur almost every quarter, earnings have actually fallen for the last few quarters.

But by the third quarter, even the so-called "adjusted" earnings that Wall Street uses have been down. S&P 500 companies reporting so far showed an average decline in earnings of 1.9% in the third quarter. That number may get worse when the final tally is in.

Despite this obvious downtrend, analysts' earnings estimates for the fourth quarter still call for growth of 8.4%. There is zero chance growth will be even near that. More likely, earnings will be lower again in Q4, and flat to negative for another couple of quarters after that. The market will probably manage only short reflex rallies until this trend plays itself out.

Tax Selling
All the major indices are still in plus territory for the year, but many (maybe most) individual components of them are not.

These indices are either price- or capitalization-weighted, meaning that the largest companies move the index more than the smaller ones. A dollar movement in Apple, for example, may move the Nasdaq more than a dollar movement in 20 smaller Nasdaq companies combined.

Hence, there may be more tax selling of stocks that are underwater year-to-date than the indices would suggest. Tax-selling pressure tends to ease up around the first or second week of December, but till then, it's likely to drag on the market.

QE Bust
Since 2009, Wall Street traders have been jumping like trained seals every time the Federal Reserve hints that there will be more Quantitative Easing, the shop-worn euphemism for printing more money. But August's big QE-induced rally stopped short after just a few weeks.

Fewer investors now buy the story that printing money can fix all ills. Even with a promise to buy $40 billion a month in mortgage-backed securities and Treasuries, the stock market doubts QE can prop up the house of cards much longer.

Real World Happenings
On Main Street America, far from Wall Street's parlor games, new initial unemployment claims jumped 78,000from last week. That's a huge number. And unadjusted claims jumped 103,000 year-over-year, another huge number. It is only the second time since May 2011 that there has been a year-over-year increase in unadjusted claims.

Employment statistics tend to lag the economy, hence they are actually not the best indicators for predicting recessions, but they're another voice in the chorus that says caution remains the byword.

The one mitigating possibility I see that countervails these factors is the aftermath of Hurricane Sandy. Disasters like these can cause a bump in GDP in the following quarter or two, as economic activity picks up to repair the damage. Employment in the building trades is the first of the obvious areas to benefit. If GDP figures improve enough, that might change the tone of the markets.

Still, the overall weight is toward further market weakness. As we've seen in the past, I'm a lot better at finding good companies to invest in than I am timing the market. So, although I believe the market is headed south for the winter, or longer, I'm not going to try to put on any additional hedges at this time.

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Related Reading:

Dow Theory Leaning Toward Sell

Weighing Latin America's Juggernauts

A Rebound in US Manufacturing?

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