Europe Is Near Term Driver of
By John Buckingham
May 29, 2012
Plenty of uncertainty surrounds developments in Europe, so I’ve chosen to pen this Memorial Day version of our Market Commentary on Monday afternoon rather than the usual Sunday evening. Of course, had the U.S. stock markets been open today, we might have seen a modest advance, given that the equity futures were suggesting that gains of some 40 or 50 Dow Jones Industrial Average points would be in the cards when trading resumes.
The catalyst for the potential move upward and the cause of the modest increases for stocks in Asia and an initial gain in European trading today was word that the latest polls in Greece showed that the conservative New Democracy party had taken a lead of between 0.5 and 5.7 points over the SYRIZA party as the country faces new elections on June 17. The New Democracy party supports the European bailout, tough austerity measures and continued residency in the Eurozone while SYRIZA, whose victories in the elections on May 6 triggered the recent global equity market downturn, opposes the bailout.
There can be no guarantees as conditions change rapidly, and we saw the very nice day that was shaping up on Friday give up most of its gains after news broke that Spain will inject $24 billion into troubled lender Bankia SA, the nation’s third largest bank, and that Standard & Poor’s cut its rating on Bankia and four other Spanish banks. We also heard over the three-day weekend that companies all across Europe are prepping contingency plans for a Greece exit from the euro. Finally, Didier Reynders, Belgium’s foreign minister and deputy prime minister, said, “There is no organized discussion at the European level along the lines of: what do we do (if Greece leaves)…Now, if central banks and companies are not preparing for the scenario, that would be a grave professional error.”
Obviously, there will be many more twists and turns in the European situation, and none of us has a crystal ball to know for sure the outcome or the impact it may have on the equity markets in the U.S. and around the world. Certainly, a disorderly exit for Greece from the euro would cause plenty of strife, especially if it triggered a run on the banks in Spain & Italy, but then again so many people are waiting for this European shoe to drop that an equity market selloff could be short-lived.
Recall that investors bought heavily into the U.S. equity markets in the fourth quarter of 2001, after bailing out in September following the tragic events of 9/11, so much so that stocks ended that year higher than where they were on September 10. And that was following a market shock for which no one had planned!
Given that stocks endured a summer swoon last year (and in 2010), we recognize that there is something to the ‘Sell in May and Go Away’ thinking. We’ve commented on numerous occasions about the seasonally favorable November–April time span, which then mathematically requires that May–October be seasonally unfavorable. Not surprisingly, this trend does not always hold, as October 2011 was a fantastic month for stocks and the average stock hit its high so far this year just as April was beginning.
More importantly, perhaps, as our current positioning favors dividend-paying stocks, the numbers we’ve crunched show that the seasonally weak six months of the year favors those companies that offer a yield. In fact, the higher the dividend yield, the better the historical return, with the usual caveat that past performance is no guarantee of future performance.
Still, with interest rates remaining at microscopic levels, it is tough not to like equities, especially as we just can’t believe that folks are doing anything but parking their money in U.S. Treasury securities these days. Yes, the world remains a scary place, and even gold has been a lousy refuge during this month’s downturn, but the current 1.74% yield on the 10-year Treasury offers little hope that long-term investors will be able to keep up with inflation, which has historically averaged 3% per annum.
While some would argue that the calendar is the least of the worries, it is somewhat reassuring to note the differences between this time last year and today. Per the Market Data section of The Wall Street Journal, the dividend yield on the S&P 500 has climbed from 1.86% to 2.13%, while the trailing P/E ratio (based on as-reported earnings) for the S&P 500 had dropped from 16.6 at this time a year ago to 14.9 today. Looking at estimated earnings, the forward P/E on the S&P was then 13.5 compared to 12.5 now. Multiples based on operating earnings (excluding non-recurring items) are even lower (and earnings per share are higher), but if we stay with the ‘as-reported’ figures, Standard & Poor’s currently (as of 5.17.12) estimates that EPS for the S&P 500 will grow from $86.95 in 2011 to $100.07 this year to $112.97 in 2013.
Turning to the domestic economy, most are aware that we generally take a contrarian view of the statistics as market bottoms are often associated with dismal data and tops with terrific numbers. That said, we did like what we saw last week with news out of the housing sector. The Commerce Department said that new-home sales for April rose 3.3% on a sequential basis and 9.9% compared to the year-ago period, while the median price came in at $235,700, up nearly 5% versus the same period last year. Meanwhile, the National Association of Realtors disclosed that sales of existing homes climbed by 3.4% in April as compared to March, the first increase in three months, while on a year-over-year basis, the median home price jumped 10.1% from a year earlier to $177,400. That increase represented the best year-over-year improvement in more than six years.
Luxury homebuilder Toll Brothers confirmed the positive trend when it reported better-than-expected quarterly results and said that orders rose to 1,290 homes from 879 a year earlier, while its backlog jumped 37% to 2,403 homes. Toll CEO Douglas C. Yearley Jr. added, “It appears that the housing market has moved into a new and stronger phase of recovery. The spring selling season has been the most robust and sustained since the downturn began.” Obviously, it doesn’t hurt that that borrowing costs hit a new record low last week as Freddie Mac reported that interest rates for 30-year mortgages inched one basis point lower to 3.78%.
Also, we learned that consumer sentiment chalked up its ninth-straight advance since bottoming last August at 54.9 as the Thomson Reuters/University of Michigan Survey of Consumers climbed to 79.3 in May. That reading was 6.7 percentage points better than at this time last year and marked the highest level since October 2007. One economist commented, “Europe is in recession and China is slowing....But the American consumer is unmoved. In fact, they are downright optimistic. Consumer confidence at a new high should make us more certain that the consumer will continue to lead this recovery going forward.”
On the other side of the coin, the Commerce Department reported that orders for durable goods rebounded to a gain of 0.2% in April, after a decline of 3.7% in March, but the modest improvement was light of expectations. In fact, when the volatile commercial aircraft component is removed, orders actually fell 1.9% in April after dropping 2.2% in March.
No doubt, there are more than a few risks to future economic growth, but it was interesting to see last week the May 2012 National Association for Business Economics (NABE) Outlook, which presents the consensus of macroeconomic forecasts from a panel of 54 professional forecasters. The survey, which covers the outlook for 2012 and 2013 and which was conducted April 19-May 2, 2012, saw a modest improvement in the forecast for the labor picture as the unemployment rate is now expected to be 8.0% in December 2012 and 7.5% by the end of 2013. Economic growth projections held steady with the respondents continuing to expect U.S. GDP to average 2.3% this year and 2.7% next.