Doubts are growing. Economic data is beginning to disappoint. Investors are taking profits and beginning to sell their best holdings. Yet, earnings are coming in better than expected. What’s an investor to do?
All week long a barrage of weaker than expected data buffeted the stock market. Weaker manufacturing and home sales, consumer confidence and rising layoffs paint a portrait of weaker economic growth and higher unemployment ahead. As I have written in the past, a stock market that is priced for perfection can’t take much more of this negative news.
On the other hand, 80% of the companies that have reported so far this quarter have beat estimates. One should take the number of “beats” cynically. It is common knowledge that Wall Street analysts reduce their earnings forecasts ahead of time so that the hurdle for beating estimates for the companies they follow is absurdly low. The entire game of earnings forecasts has become somewhat of a joke within the investment community.
Europe continues to cast a long shadow over U.S. investment. Spain’s bond auction this week had everyone on edge. It came in poorly but it wasn’t a complete disaster. Markets in the beginning of the week sold off in advance of the auction. Investors expected the market to rally but instead we had one of those extremely volatile up and down days that made everyone’s stomachs churn.
This weekend investors’ eyes will be glued to French election results. The French electorate will choose among 10 candidates with a May 6 runoff scheduled between the top two winners. Socialist challenger Francois Hollande is expected to win this weekend’s vote. He has promised to revisit the European Union’s fiscal austerity agreements if elected. Investors fear this will upset the entire European financial pact, of which France is an integral player. That leaves more tension and more stress for market participants.
The market internals continue to deteriorate. I have noticed that while the volume on upside days is anemic at best, the volume expands substantially the days the market sells off. Take Thursday, for example. It was a down day and volume was 20% higher than normal. It indicates that investors are cashing in on the gains of the first quarter every time the stock market gets close to its upper limits.
We seem to be trading in a narrow range around S&P 500 Index’s 50- day moving average. At the moment that level is 1,380. Remember, a moving average is just that and it changes from day to day. Clearly we have not made any progress at all since the end of the first quarter. In fact, we have lost 2% since then.
One can argue that the markets are simply catching their breath after their three month sprint. I don’t disagree with that prognosis. As I have mentioned before, there are several ways a market can digest gains. The first is through a pullback commonly known as a correction (if it exceeds 10%). The second involves a lot of backing and filling that sometimes can stretch out for several weeks or months. Either way the market consolidates its gains and is then ready for further upside.
There are also times in which a market will do both. Decline, churn, drop again, churn and so on until it reaches a level where investors believe it offers value based on economic and other factors. I suspect we are in that kind of market for a little while. We are also fast approaching May. We have all heard the expression “Sell in May and go away.” Historically speaking, that has been very good advice. I await the end of the month with bated breath.