Monday, April 15, 2013

Facade of Strength?

Chuck Mikolajczak of Reuters reports, Wall Street Week Ahead: A year of returns, all before mid-April:
The S&P 500 stock index's stunning run since the start of the year has made many bullish analysts look conservative.

As the benchmark S&P .SPX has roared to record highs this year with a gain of more than 11 percent, many Wall Street analysts have been forced to concede their prior targets were too low and adjust accordingly.

In fact, it has taken less than four months for the S&P to surpass year-end 2013 targets of about two-thirds of the strategists polled by Thomson Reuters in December. Of 47 analysts surveyed, 30 of them expected to see this year end at a level already exceeded by the index.

The midyear targets are even more lopsided, as the S&P is above the midyear forecast for 27 of the 28 analysts who estimated where the index would be by the end of June.

"When we started the year at 1,425 that implied about a 15 or 20 percent total return," said Phil Orlando, chief equity market strategist, at Federated Investors, in New York, who has a 1,660 year-end target for the index.

"Here we are now 3 1/2 months into the new year and stocks are up 11, 12 percent - there's not a whole lot left. Either there's going to be a pullback at some point, or maybe things really get even better than we thought and our 1,660 target is too low."

The more recent Reuters poll in March showed some analysts had revised targets following the strong start to the year, with the S&P above the midyear target for 21 of 34 analysts surveyed and the full-year target for 18 of 43 analysts surveyed.

The run has been notable for its resilience. As investors buy into weakness, dips are short-lived while bears are forced to cover short positions and asset managers chase performance.

So far this year, the S&P has only experienced three consecutive losing sessions once, and the deepest "correction" was a brief 2.8 percent slide in late February.

Thomas Lee, U.S. equity strategist at JPMorgan in New York, this week decided to throw in the towel on a call for a correction, saying in two recent notes to clients that his 1,580 target for the year-end S&P "seems low." Data in the last six weeks has not been as weak as some expected, and the equity market managed to look past it, anyway.

Lee, in his commentary, notes that JP Morgan estimates 2013 currently is the worst year for active-manager performance since 1995, with an estimated 68 percent of funds falling short of their benchmark. Fund managers, as a result, are taking on more risks in order to play catch-up, he wrote.

Now that Lee is more bullish, he noted the biggest risk to this new view is "that the market begins to correct just as we capitulate on it happening. That is potential irony."

Fred Dickson, chief market strategist at D.A. Davidson & Co in Lake Oswego, Oregon, who is maintaining his target of 1,450 for midyear and 1,500 for the year-end sees a strong likelihood of a significant pullback, partly due to the current market structure which contains a large number of program-driven traders that follow trends.

"It will take a combination of fundamental events to pull people from a buying mode onto the sidelines and when that happens we will start to see prices decline. As those prices decline the program traders flip the switch from buy to sell or buy to short and you get a fairly rapid 8 to 10 percent decline," said Dickson.

One potential catalyst for a pullback could be company results as the pace of earnings season begins to pick up.

Earnings for S&P 500 companies are expected to grow at a modest 1.1 percent in the first quarter, down from a January forecast of more than 4 percent, according to Thomson Reuters data. Just 6 percent of companies have reported thus far, but companies so far have been notably pessimistic, with a 4.7-to-1 ratio of negative to positive warnings.

"The only thing that happens now is do we start to see something in the company earnings reports - these are really important because that is where the rubber meets the road," said Gordon Charlop, managing director at Rosenblatt Securities in New York.

Next week 74 S&P companies are expected to report results, across a wide swath of sectors. Financials dominate the week, including reports from American Express Co (AXP), Goldman Sachs (GS), Bank of America (BAC) and Citigroup Inc (C).

Internet companies Google Inc (GOOG) and Yahoo Inc (YHOO), along with Dow components Johnson & Johnson (JNJ), Coca-Cola (KO), McDonald's Corp (MCD) and General Electric (GE) also report results.

In addition to earnings, investors will also scrutinize regional manufacturing data from the New York and Philadelphia Federal Reserve banks, the Fed's Beige Book and data on consumer inflation and housing starts.
It's not just fundamental analysts that were caught off guard by this market. Tomi Kilgore of the WSJ reports, Technicians Frustrated: Stocks Surge Despite ‘Sell’ Signals:
Technical analysts face a conundrum.

A laundry list of widely followed chart signals are screaming “sell.” But lately, whenever stocks pull back, investors are waiting, telling their brokers “buy.”

That’s making the stock market rally a frustrating experience for many technicians. They believe what their charts are telling them, but the market isn’t cooperating.

“This is an unwarranted, unhealthy and thoroughly frustrating uptrend,” said Tom McClellan, editor of The McClellan Market Report. “But it is an uptrend.”

The Standard & Poor’s 500-stock index has extended its march to record highs, helped by stepped up interest in U.S. stocks from individual investors and money coming in from overseas.

But many technicians feel compelled to continue warning that a significant pullback may be imminent. They point to a wide variety of negative signals, from “bearish engulfing” patterns to reaching Elliott Wave objectives, and from bearish momentum “divergences” to declining participation.

“Nobody likes a bear in a bull market,” said Richard Ross, chief global technical strategist at New York broker dealer Auerbach Grayson. “But I have to stay true to what I do. It’s my job to point out the glitches in the matrix,” Mr. Ross said.

The best performing sectors this year are health care, consumer staples and utilities, which have historically been viewed as defensive. In addition, European and emerging markets continue to struggle, commodities prices are still trending lower, and Treasurys have rallied sharply over the last month, all of which warn that a defensive posture is warranted (click chart below).

Mr. Ross said investors should keep in mind that a rise in the S&P 500 doesn’t necessarily prove the bearish case wrong. Considering how many intra- and inter-market signals suggesting a top is near, he maintains conviction in his methodology. “I’d have to be wrong on a whole bunch of things before I’d believe I was wrong on stocks,” he said.

And yet, the S&P 500 surged 1.2% to an all-time high of 1587.73 Wednesday, busting out of the narrow 1.5% range the index had been stuck in over the last month.

Helping fund the gains, TrimTabs Investment Research said the U.S. equity mutual funds and exchange traded funds it tracks have taken in $60 billion in new money so far this year, which is already the highest in any full year since 2004.

The question for technicians is, does the study of the behavior of European and emerging markets, commodities and cyclical and non-cyclical sectors even matter, when money is pouring into the stock market?

Technicians maintain that the answer is “yes,” because over the longer term, it matters more where the money is going than how much is coming into the market.

Robert Sluymer, technical analyst at RBC Capital Markets, said many of his mutual fund and pension fund clients, who seek to outperform the broader market, are more interested in knowing what’s outperforming and what’s underperforming than what the S&P 500 is doing.

“I’m pretty agnostic on the market in general,” Mr. Sluymer said. “My job is to identify what is leading the market, and what isn’t.”

He recognizes that the overall trend of the S&P 500 may still be up, but he continues to point out to clients the “significant shifts in leadership underneath the index” that might normally be construed as warning of a near-term pullback.

For example, Mr. Sluymer noted the industrial sector had peaked relative to the S&P 500 in late February, and has been trending lower ever since (click chart below).
That’s what makes the current rally so difficult for technicians to follow.

“The bets that are working here…are not the type of bets, or trades, I’d be wanting to make at this point,” Auerbach Grayson’s Mr. Ross said. “That’s the conundrum.”
Another excellent market technician, J.C. Parets of All Star Charts, notes the following when going over all the sectors in a recent comment, A Look Inside the US Stock Market:
These historically more defensive groups are ripping to new highs. These sectors are the reason that US Stock Market Averages are anywhere near highs. A lot the components of the market aren’t participating. I speak to all different kinds of investors every day and a common theme I’m hearing is that their portfolios are underperforming the broad averages. They read that US Stocks are making all-time highs, so they look at their portfolios and wonder why theirs are not at new highs, and haven’t been for months. My explanation to them is that, in reality, the “market of stocks” peaked in January. So unless your “portfolio” is the SPX Index you’re not performing as well as that average.

We’re in a current market environment that is being driven by just a few sectors. The majority of the others have been drifting lower for 4 weeks. So as participants that own stocks, not the SPX Index, we need to recognize where the strength is coming from. If you trade E-mini contracts or just trade $SPY all day, then this doesn’t affect you. But most people are in individual names or spaces.

And even when you look at the index itself, the S&P500 has really been trading sideways for 4 weeks. It hasn’t gone anywhere while it’s been in this Christmas light formation of up day/down day/up day/down day for what I understand is a record amount of days.

So careful what you read in the headlines about all-time highs. There are weak sectors within the market, and there are some really strong ones. The bulls want to see some rotation out of the defensives and into the sectors that have been struggling if this market is going to keep grinding higher. The bears want to see follow through from the struggling ones and have the leaders play catch-up to the downside.

I find that it’s a helpful exercise to look at the components of the market and see how they’re faring against each other and also against the broader average. I guess we’ll see how this develops.
Over the weekend, caught up on my readings. Niels Jensen of Absolute Return Partners wrote another excellent comment, The Need For Wholesale Change. Don't agree with everything he writes but his monthly comments are superb and thought provoking, a must read for any serious investor.

Also spent time trying to figure out the stock market and came up with the conclusion that deflation is the dominant theme, which could signal bad days ahead for stocks. What else explains the rally in bonds and defensive sectors, slaughter in commodities, the huge underperformance in materials and energy, and the plunge in gold prices/ obliteration of gold mining shares? (John Paulson is getting killed and so is Eric Sprott)

Finally, I exchanged a few tweets with Michael Gayed, chief investment strategist and co-portfolio manager at Pension Partners. Michael wrote a great comment on the honey badger stock market, and over the weekend warned, Something's Gotta Give:
While many talk about the trend in U.S. stock prices, no one is talking about the trend in conditions which are clearly signaling deflation despite the Fed's $85 billion/month. With commodities down (cost-push), and the jobs market still not signaling any real acceleration (demand-pull), the two most basic forces of inflation aren't doing much at all. This is what Ed Dempsey and I have been stressing since the end of January with many ignoring what internal price is clearly saying.

This is one of the most risk-off risk rallies in history, which is highly deceptive given what is causing it. I went from calling this a market which could be set up for a correction in late January to the honey badger stock market which simply does not care about negativity in nearly every other area of the investable landscape.
However, make no mistake about it - something's gotta give. There will be a Spring Sync. Either absolute price movement will converge on the downside to intermarket deterioration, or that deterioration through time will resolve itself and the next fat pitch comes in the cyclical trade. If the former, it is entirely possible a sharp sell-off occurs despite Fed intervention. If the latter, cyclicals have the potential to make any year to date gains in stocks look more like a rounding error.
Keep all this in mind as you watch the bull market that gets no respect make new highs, for now. This is a frustrating market which is why most active managers are underperforming and wondering whether now is the time to dial up or dial down risk.

Below, Ed Demspey, CIO of Pension Partners, discusses their ATAC model, global markets, Q1 earnings and beyond with Carrie Lee. Great insights on the facade of strength (video taken 4/9/2013).

And Kathleen Kelley, CIO at Queen Anne's Gate Capital Management, discusses the role of women in finance and her outlook on gold and commodity shares. Pete Najarian opens clip discussing volatility hitting a multi-year low.