Week in Review: 1/23/12 – 1/27/12
The major market indices finished the week mixed to modestly higher. The S&P 500 has now gained in five of the past six weeks.
Performance for Week Ending 1/27/12:
The Dow Jones Industrial Average (Dow) lost 0.47%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) rose 0.36%, the Standard & Poor’s 500 Index (S&P 500) added 0.07% and the Nasdaq Composite Index (Nasdaq) tacked on 1.07%. Sector breadth was neutral as five of the S&P sector groups finished higher while five finished lower. The Materials sector (+1.50%) was the best performer while the Telecom sector (-4.31%) was the worst. The Canadian market, as measured by the S&P/TSX Composite Index, gained 0.56%.
| Index* | Closing Price 1/27/2012 | Percentage Change for Week Ending 1/27/2012 | Year-to-Date Percentage Change Through 1/27/2012 |
| Dow | 12660.46 | -0.47% | +3.63% |
| Wilshire 5000 | 13671.05 | +0.36% | +5.21% |
| S&P 500 | 1316.32 | +0.07% | +4.67% |
| Nasdaq | 2816.55 | +1.07% | +8.11% |
| S&P/TSX Composite | 12466.50 | +0.56% | +4.28% |
*See Last Page for Index Definitions MARKET OBSERVATIONS: 1/23/12- 1/27/12
The major market indices finished the week mixed to modestly higher. Trading however was very choppy as the battle between greed and gravity appears to be heating up. The solid rally that has been in place since early-October has left the markets in an “overbought” position at a time when complacency has become very elevated. Emotions—fear and greed—are often determining factors in making investment decisions. These emotions also tend to be contrarian in nature, meaning fear is almost always lowest near market peaks and almost always highest near market troughs. With the CBOE Volatility Index (VIX), which tends to be a good barometer of fear in the market, at a six-month low and the market up almost 20% since early-October, the market appears vulnerable for a near-term pullback. While the ‘gloom and doom’ headlines have mostly fallen off the front pages, the threat and negative consequences of a policy-related mistake, particularly in Europe, still very much exists.
With that said, I remain a believer that periodic pullbacks—which we have been generally devoid of as of late—are healthy in the context that they help keep expectations in check and weed out excesses that tend to get built into stock prices. I also believe that consolidation periods generally set the stage for the next phase higher. Ultimately it’s fundamentals (earnings, interest rates, valuation, etc) that drive stock prices and as we transition to the next phase of the market cycle, the fundamental environment in the U.S. remains very healthy and ultimately should become the driving force to further gains in the markets. In addition, while the market may be in need of a breather (a pause to refresh) it’s hard not to be upbeat on risk assets with almost every major central bank around the globe in some sort of easing effort to backstop its respective markets/economies. This scenario suggests that any pullback may be short and shallow and should be viewed as a buying opportunity, especially for investors with a longer-term time horizon.
FOMC Meeting
The focal point of the past week was the two-day Federal Open Market Committee meeting where Fed officials essentially pledged to keep rates lower for longer. The Fed’s after-meeting communiqué stated that “economic conditions are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.” This “dovish” language and the lowering of forward economic growth expectations likely leaves the door wide open for additional monetary efforts sometime this year.
While any decision to initiate additional quantitative easing efforts will likely be data dependent, the Fed’s downbeat forward outlook likely gives it cover to reopen the liquidity spigots at some point this year. While the likelihood remains that any new action could occur in the third quarter following the June conclusion of “operation twist,” the fact that it is an election year could lead to additional action sooner rather than later. The Fed will likely want to try and stay as far away from the November elections as possible.
We have to keep in mind that the Fed has a dual mandate—full employment and price stability. While inflation appears to be trending lower and is likely to fall inline within its 2% comfort zone, the bottom-line is that unemployment remains too high and growth too timid to adequately jumpstart hiring. Based on the Fed’s “long-run” unemployment rate projection range of 5.0% - 6.0%, and the fact that it sees the “average” unemployment rate dropping to only 7.0% by the end of 2014, the current rate of 8.5% is too high. In other words, the Fed remains legally obligated to do what it can to responsibly push the economy back toward these mandates.
Q4 GDP
On Friday, the Commerce Department reported that the preliminary reading on fourth quarter gross domestic product (GDP) showed the economy expanding at a 2.8% rate, slightly short of the 3.0% rate expected by economists. Personal Consumption rose by 2.0% also short of economists’ expectations. While the GDP data was slightly disappointing, the rate of growth is still the strongest since the second quarter of 2010. In addition, GDP data is backward looking as it reflects economic conditions from the October to December 2011 period. Remember that markets tend to be forward looking, and therefore putting too much emphasis on dated economic statistics is like trying to drive a car by looking in your rear view mirror. With that said, the Q4 data, while short of economists’ expectations, does confirm that economic growth gained traction over the course of the year with solid sequential growth over the past three quarters.
Q4 Earnings
Through Friday, 196 members of the S&P 500 have reported quarterly results, with overall earnings up 3.5%. When the volatile Financials sector is excluded earnings are up a more respectable 10.3%. Of the companies that have reported, 59% have beaten analysts’ expectations while 30% have fallen short. The current “beat” rate is falling slightly short of the historical 61% average and well below the pace achieved in recent quarters. When all is said and done, fourth quarter earnings for the S&P 500, according to Bloomberg data, are expected to rise 4.6%, a sharp slowdown from recent quarters and a fraction of the 14.1% that was estimated at the start of October. While overall earnings have been generally lackluster, there have been many bright spots including the blowout results from Apple Computer (an excellent proxy for consumer spending) and 3M, which is seen as an economic bellwether due to its broad geographical reach and diverse product line-up.
Looking Ahead
The focal point of the upcoming week will be Friday’s release of the January Payroll data. According to Bloomberg data, economists are expecting nonfarm payrolls to rise by 150K and for the unemployment rate to remain unchanged at 8.5%. Private payrolls—which filter out government hiring/firing—are expected to rise by 170K. Other economic reports of interest include the ISM Manufacturing and Non-Manufacturing reports, several regional manufacturing reports and initial jobless claims on Thursday. Earnings reports will also remain on the front burner with 99 members of the S&P 500 scheduled to report results. Fed heads will also be out and about this week with four speeches on the docket including Fed Chairman Bernanke’s testimony to the House Budget Committee on Thursday.
MARKET VIEWPOINT
I continue to believe that the U.S. equity markets remain well positioned for positive performance over the course of 2012. This upbeat viewpoint reflects the markets’ attractive valuation, the overall healthy nature of corporate balance sheets, expectations that corporate profits will remain strong, and the pledge from the Federal Reserve that monetary policy will remain accommodative through late-2014. In light of the favorable macro environment, I continue to believe that market weakness represents an attractive entry point, especially for longer-term investors.
Potential Risks/Wildcards: Expectations that equity prices will trend higher over time assumes that a resolution to the debt problems in Europe will be found, that monetary policy will remain accommodative, and that no major fiscal policy mistakes are made. An adverse outcome to any of the above factors would likely lead to a reevaluation of the bullish outlook.
Definitions
The Dow Jones Industrial Average is a price-weighted average of 30 blue-chip stocks that are generally defined as the leaders in their industry. It has been a widely followed indicator of the stock market since October 1, 1928.
Wilshire 5000 Total Market IndexSM represents the broadest index for the U.S. equity market, measuring the performance of all U.S. equity securities with readily available price data. The index is comprised of virtually every stock that: the firm’s headquarters are based in the U.S.; the stock is actively traded on a U.S. exchange; the stock has widely available pricing information (this disqualifies bulletin board, or over-the-counter stocks). The index is market cap weighted, meaning that the firms with the highest market value account for a larger portion of the index.
Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The Nasdaq Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The index was developed with a base level of 100 as of February 5, 1971.
The S&P/TSX Composite Index is a capitalization-weighted index designed to measure market activity of stocks listed on the Toronto Stock Exchange (TSX). The index was developed with a base level of 1000 as of 1975.
The Chicago Board Options Exchange Volatility Index (VIX) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices.
Indices do not include any expenses, fees, or sales charges, which would lower performance. Indices are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.
The individual companies mentioned in this piece were for informational purposes only and should not be viewed as recommendations.
The comments should not be construed as a recommendation of individual holdings or market sectors, but as an illustration of broader themes. This document contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Information in this report does not pertain to any investment product and is not a solicitation for any product. This material has been prepared using sources of information generally believed to be reliable. No representation can be made as to its accuracy.