Europe Is Near Term Driver of Market Movements
AFAM
By John Buckingham
June 12, 2012
Equities Soar, Treasuries Plunge
Though
the dates do not coincide, as there is a lag in the Investment Company
Institute data, last week’s rally in stocks was accompanied by word that
for the first time in seemingly forever, mutual fund investors actually
put more money into domestic equity funds than they took out, while the
reverse was true for bond funds. Indeed, for the week ended May 30, a
net $807 million flowed into U.S. stock funds, compared to a $7.2
billion net outflow in the week prior, while a combined net $317 million
was redeemed from taxable and municipal bond funds, versus an inflow of
$2.8 billion in the preceding week.
Because
it is only one week and Memorial Day was part of those ICI numbers, we
hesitate to say that the tide is finally turning in terms of investor
sentiment. In fact, our friends at the American Association of
Individual Investors (AAII) remain very pessimistic on the prospects for
stocks over the next six months as for the week ended June 6, only
27.5% of respondents were Bullish compared to 45.8% who were Bearish.
Also,
Mark Hulbert’s Nasdaq Newsletter Sentiment Index (HNNSI), which
reflects the average recommended equity exposure level among those stock
market timers tracked by the Hulbert Financial Digest who focus on the
Nasdaq market in particular, hit its most bearish reading (minus 47.1%)
since early September 2010 on June 1. Illustrating the difficulties of
market timing, these newsletter writers were heading into last week with
nearly half of their portfolios shorting the Nasdaq market, only to be
caught leaning the wrong way when the Nasdaq Composite index climbed 4%
over the ensuing week. Believe it or not, Mr. Hulbert writes that the
last time the HNNSI was this low was back in September 2010 when the
Nasdaq Composite index was 2209. Three months later, the Nasdaq was
nearly 18% higher!
No
doubt, there are those who have successfully timed the market, but as
Peter Lynch has said, the only problem with market timing is getting the
timing right. Last week was a perfect example as virtually no one,
including yours truly, was expecting the big upward bounce. The New York
Times on June 1 cited a prominent analyst who said, “People are very
risk-averse right now. What it tells you is investors are anxious and
are willing to forgo a lot of potential return for the ability to park
their money with what they perceive to be high quality, safe
governments.”
The Wall Street Journal summed up well the mood of investors in last Monday’s edition:
“Investors
across financial markets have reacted with increasing alarm at the
drumbeat of bad news from all corners of the world, with economies
sputtering just as troubles in Europe flare anew. Concerns that Greece
may be forced to exit the euro zone have joined worries that Spain may
also collapse under the pressure of a high deficit and fragile banking
system…Potential market land mines dot the horizon. Greece holds new
elections June 17 that will largely determine its course. The Federal
Reserve's rate-setting committee, scheduled for June 19 and 20, could
signal leanings toward further stimulus. And on June 28 and 29, a summit
of European Union leaders in Brussels will be closely watched by
investors for evidence that policy makers will increase efforts to solve
the region's crisis.”
Of
course, we did comment on last week’s missive that the fear/greed
pendulum had swung pretty far in the direction of the pessimists and we
noted that when so many folks are convinced that the market is heading
in one direction, it often pays to be a contrarian. There is certainly
no guarantee that the rebound will be long-lasting, despite the big
rally in the equity futures on Sunday night, but it is also important to
remember that these days central bankers and government officials are
doing all that they can to boost their economies, as evidenced by this
weekend’s announcement that Spain secured a 100 billion euro ($125
billion) loan to bolster its banking system. We also saw China last week
make a surprise cut to interest rates, with more cuts possible,
especially given this weekend’s benign inflation data out of the Middle
Kingdom. And though the European Central Bank did not cut interest rates
last week from the current 1.0% level, its president Mario Draghi
reminded all, “We will stand ready to act.”
Here
at home, some thought Federal Reserve action was imminent after Janet
Yellen, vice chairwoman of the Federal Reserve Bank, commented, “I am
convinced that scope remains for the [Fed] to provide further policy
accommodation.” Fed Chairman Ben Bernanke suggested otherwise, when he
told the Congressional Joint Economic Committee, “Economic growth
appears poised to continue at a moderate pace over coming quarters,” a
position supported by the relatively upbeat tone to the Fed’s latest
Beige Book.
The
economic statistics out last week were also keeping with the view that
the economy is growing at a moderate pace. The Labor Department said
that first-time claims for unemployment benefits reversed four weeks of
increases, declining by 12,000 to a seasonally adjusted 377,000 in the
week ended June 2 and beating analyst forecasts. Also, the Conference
Board disclosed that its employment-trends index moved higher by 0.29%
in May with the data provider stating, “Employers have been very
cautious in hiring in the past two months, but at the moment, economic
activity in the U.S. is just strong enough to require a modestly growing
workforce.” Finally, the Institute for Supply Management said that its
index of nonmanufacturing activity inched higher to 53.7 in May, up from
53.5 in April, with any reading above 50 (where the gauge has been now
for 29 straight months) signifying expansion in the service sector.
True,
economic conditions are hardly robust, especially as the Commerce
Department also reported last week that factory orders dropped 0.6% in
April, following a revised big decline of 2% in March, but we would
continue to argue that stock prices are discounting a worse economic
climate than is likely to materialize. Standard & Poor’s, which
affirmed its 'AA+' long-term and 'A-1+' short-term U.S. sovereign credit
ratings this past Friday afternoon, stated that its base case expects
annual real GDP growth of 2%-3.5% and consumer price inflation near 2%
through 2016, outlooks that appear to be in line with what we’ve heard
from the Federal Reserve as well as private economists.
Most
importantly, perhaps, though estimates have been coming down in recent
weeks due to the turmoil in Europe where something on the order of 15%
of sales for companies in the S&P 500 are generated, Standard &
Poor’s now projects that bottom-up operating earnings per share for the
S&P 500 will grow from $96.44 in 2011 to $104.54 this year to
$118.51 in 2013. With the benchmark not that far above 1300, equity
valuations remain quite reasonable in our view, especially when interest
rates are hovering near all-time low levels.
(c) AFAM
