Bullish, but Beware Volatility
04/01/2013 9:00 am EST
While we can continue to expect some pullbacks, we remain in a long-term bullish cycle, says Sam Stovall of Standard & Poor's Capital IQ Equity Research.
The daily grind higher in US equity prices is acting like water torture for both bulls and bears, in our view.
The bulls worry about waning momentum, as the tractor beam of the prior high seems to lose leverage the closer the market gets. However, bears flinch at the daily increase by low-to-mid single-digits in the S&P 500, though steadied by the conviction that the index will likely fail to eclipse the prior high on its first attempt.
But just as the Catholics were recently in search of a new Pope, investors are in search of a new catalyst to trigger the next move. We think the “500” will likely experience setbacks in prices both before and shortly thereafter establishing a new high, but will remain in a long-term bull market.
Investors were encouraged by the better-than-expected retail sales report for February, as many expected sales to be slowed by higher payroll taxes and delayed tax returns. Also encouraging was that while gasoline sales rose, so too did sales of automobiles and other areas.
This strong report comes on the heels of last week’s better-than-expected rise in February non-farm payrolls and a reduction in the unemployment rate.
According to Capital IQ consensus EPS estimates for the next 12 months, the S&P 500 is trading at a P/E ratio of just below 14, which is a discount of 13.8% from the average P/E of 16.2 since this secular sideways move started in early 2000. If investors felt confident enough in the global economic growth scenario to apply the expanded long-term average multiple, the S&P 500 would be trading closer to the 1,780 level.
One worry has been the prospect of a rising US dollar’s impact on equity prices. With the rolling 36-month correlation between the S&P 500 and the dollar at -0.7—its lowest level since 1988—a reversion to the mean of -0.09 could allow for a strengthening of stocks as well as the dollar, in our view.
We expect at least a minor top in equities, as the S&P 500 has run up to major long-term resistance, bearish divergences are seen on daily charts, weekly momentum has cycled into overbought territory, and many sentiment gauges show high levels of optimism toward equities.
The "500” has advanced to what could potentially be a tough area of chart resistance from the major tops seen in 2000 and 2007. In addition, the S&P MidCap 400, SmallCap 600, and the Dow Transports have traced out double bearish momentum divergences.
Finally, the Consensus Market Poll of professional and retail investor sentiment recently registered 75% bulls, the highest since March 2011 and 2012, both of which preceded (but didn't guarantee) market pullbacks.