Go-Go Market Keeps on Rising
03/27/2013 9:00 am EST
While some stocks are overbought, Jon Markman of Strategic Advantage says that looking beneath the hood of the market presents some interesting opportunities for the next quarter or so.
Although the media has focused on the Dow Industrials' advance to a new high, it's worth noting that the S&P 500 remains shy of its 1,576 all-time intraday high.
Bespoke Investment Group analysts made a good point about recent market breadth. They observed that even though the Dow was up ten days in a row through Thursday, only two stocks in the index had a streak of even three days in a row. That's a sign of broad participation, showing it's not just a handful of stocks pushing prices higher.
Stocks broadly are back to being highly overbought and due for a pullback. The new Eurozone turmoil will provide that excuse. Yet breadth statistics suggest that whatever the steepness of the pullback, it is likely to conclude fairly soon and lead to higher prices in the second quarter.
We have learned repeatedly in the past few years that troubles in Europe cannot permanently drag down the United States. American multinationals may bend, but they won't break.
Now let's get down more in the details. Bespoke published a valuable analysis of recent relative strength of sectors by market cap. It found that consumer discretionary large caps—retailers like Target (TGT) and wholesalers like Nike (NKE)—are beating the market by 6 percentage points in the last year, but small-caps in the group are dead even with the market. Among financials, big caps are up 8% in the past year, while small caps are up just 2%.
The dollar has been rallying, and this has underpinned the success of stocks. That may sound odd, because in recent years stocks have responded better to a falling dollar. But Bespoke analysts published a study Friday that showed the average return on the S&P 500 during the past five dollar bull markets has been +71.9%, while dollar bear markets have yielded only a 15.6% gain.
Sectors that historically have performed best during dollar bull markets are financials, consumer discretionary, tech, health care, and industrials. Performing worst have been materials, utilities, telecom, energy, and consumer staples.
The analysts also argue that few economic indicators have been more correlated lately to the performance of stocks than initial jobless claims. This makes sense, as the more Americans that are working—and the fewer that are receiving aid, and the more that are paying taxes—the better the prospects for stocks.
On the earnings front: Recent research by Citi showed US stocks' return to 2007 levels was fundamentally justifiable because the move coincided with an equivalent advance in earnings over that time. I’ve applied this analysis to sectors, and the chart is below.
You can see the Consumer Staples and Health Care stocks (diamonds) have moved up in sync with their earnings growth (gray bars), while Materials, Utilities and Financials stocks have all moved down in sync with their earnings.
The biggest anomaly has been Information Tech, at the far left, where prices are flat with 2007, and yet earnings are up 60%. Likewise, Consumer Discretionary is interesting too, as its earnings are up 40% but prices are only up 10%. This suggests shares of tech and consumer discretionary companies may be steeply undervalued, and have ample opportunity to advance to sync up with their earnings growth.