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Pop, Crackle, Then Snap?

06/11/2013 6:30 am EST


Sam Stovall

Chief Investment Strategist, CFRA Research

It's a familiar refrain: Although pullbacks are likely, Sam Stovall of S&P Capital IQ thinks the bull cycle is still intact...for now.

With the yield on the ten-year Treasury note on the ascent, stock investors are again worrying that the US economy is likely to grow more rapidly during the second half of the year, causing the pace of Fed bond buying to decrease as Treasury rates increase.

The year 1994 is frequently mentioned in whispered tones as if it should send shudders up our spines. Yet during that year, when the Fed raised rates six times (and a seventh in 1995 for good measure), the S&P 500 fell only 8.9% in price from a high in January to a low in April, and posted a 1.3% full-year total return. What's more, the Barclay's Aggregate fell less than 4% for the year.

We still think a pullback in equity prices is likely, but we expect the bull trend to remain intact.

Economic Update
A major headwind in the form of the federal spending sequester will likely reduce annualized real GDP growth to 2.1% in the second quarter from 2.5% in the first.

With the debt ceiling coming back into force on May 19, we now assume that the sequester remains in effect until sometime in the third quarter, rather than ending in Q2 as we had expected in March. As a result, we reduced Q3's growth estimate to a still-high 4.5% from the 5% rate we forecasted in April.

Additionally, we now expect the US economy to expand 2.5% for the year, versus 2.7% earlier. Beyond the fiscal battles in the near term, we think a prolonged sequestration will slow the US economy, pushing 2013 growth closer to 2% the longer it remains in place.

Fundamental Update
With 490 companies in the S&P 500 having reported Q1 earnings, the year-over-year advance is pegged at 5.13%. The projected results for Q2 through Q4 of this year, according to Capital IQ consensus estimates, are for gains of 3.4%, 6.8%, and 11.6%, respectively, leading to a 6.8% rise in 2013 on top of the 4.5% advance recorded in 2012.

At 1,648, the S&P 500's trailing 12-month P/E of 15.7 is nearly 12% below its median P/E of 17.8 over the past quarter-century. Also, based on Capital IQ's consensus EPS estimate for the next 12 months of 112.87, the S&P 500 is trading at 14.6 times earnings, or 10% below the average P/E of 16.2 since 2000. At a P/E of 16, the S&P 500 would be trading closer to 1,805.

Technical Update
The minor uptrend off the mid-April pivot low ended abruptly, as we have seen two fairly nasty downside reversal days since last Wednesday. However, the recent lows from last week have held so far, and the damage has once again been limited.

The key "500" area for the near term is the recent low at 1,635. If this level is taken out in the short term, we think the "500" could drop to fairly strong technical support at 1,600.

The one problem with calling for a big pullback is that we do not see the requisite topping formation on an intermediate-term basis that usually takes months to trace out. Therefore, we think the most likely call is for a pop (possibly to 1,700) before the market finally drops.

Read more from S&P Capital IQ here...

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