Stocks Set New, All-Time High, But Now What? – Published in Noozhawk on Monday, April 1, 2013

Stocks ended the first quarter of 2013 with very strong performance, setting a new, all-time high for the Standard & Poor’s 500 on the final trading day of the quarter at 1,569. The Dow was the best performing of the three major indexes, gaining 11.3 percent to log its best quarter since 1998. The S&P 500 gained 10 percent for the quarter, almost matching the index’s 12 percent gain in the first quarter of 2012. The Nasdaq lagged slightly, adding a still impressive 8.2 percent. All three indexes gained more than 3 percent in March alone.

For emerging market stocks, it was the worst first quarter since 2008, with theMSCI Emerging Markets Index losing 2.1 percent during the quarter. The BRIC countries all posted losses for the quarter, with Brazil, the worst performer, losing 7.8 percent, Russia dropping 2.6 percent, India falling 3.6 percent and China down 1.3 percent.

During the first quarter, some Asian markets performed well, with Japan up 19 percent, the best performer, followed by Australia up 7 percent, although others were down, including Hong Kong, which lost 1.6 percent. This backdrop of poor stock performance and weakening growth in emerging markets is in stark contrast to the conditions witnessed when U.S. stocks set all-time highs back in 2007. Further, conditions for the U.S. economy were far better, as they were across Europe (and just about every other region of the world).

The nearby table presents a comparison of the global economic environment in October 2007, the last time we set an all-time high for the S&P 500, and today:

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As can be seen in the table, just about everything was positive back in 2007, which is in stark contrast to today’s conditions. The U.S. gross-domestic product growth rate and unemployment rate really underscore the marked difference between then and now, as do the GDP growth rates for the BRIC countries. The significant outliers are the S&P 500 earnings and price-to-earnings ratios, which directly address stock market valuation concerns I have. Earnings have increased from $82.54 to about $99 (we don’t have the final number yet), or by about $10 or 11 percent. This is certainly a significant difference, and, as evidenced by the P/E ratio comparison, indicates that at least on a trailing earnings basis, stocks are somewhat cheaper today.

Although the valuation data may appear to justify current stock market levels, we need to understand that stocks trade on future expectations, rather than solely on historical information. Another point, which should be obvious, is that stocks peaked (set an all-time high) in October 2007. (We all know what happened to stocks after that.)

The estimate for S&P 500 earnings for the coming 12 months is about $112. At today’s level for the S&P 500, that gives us a forward P/E ratio of 14 times, which looks pretty low, making stocks appear fairly cheap and possibly a good buy. But, as with all estimates, the devil is in the details, or in this case, in the accuracy of that estimate. If stocks achieve these earnings results, then one could make the argument that stocks are still relatively cheap and therefore have more room to increase. If, however, stocks disappoint and are unable to achieve earnings expectations, they could appear expensive, causing a possible correction.

Those who read my column or my blog will know I have been expecting a correction for a few months, from the early part of the first quarter. My reasoning for this is multifaceted, but in general I think earnings will be disappointing, and that there are many risks, such as Cyprus, Slovenia and other European Union countries that are in dire financial condition, unemployment in the United States, the end of quantitative easing later this year — the Fed’s bond-buying program that is flooding the economy with $85 billion a month in cash, slowing global GDP growth rates, and many other factors.

If earnings are disappointing, and given the risk of some other major global economic negative occurring, I believe we could see at least a 20 percent correction in stocks. April tends to be a tough time of year historically for stocks, partly due to tax time, and partly because it follows the first quarter, within which in many years we see strong stock performance. Last year we gained 12 percent in the first quarter on the S&P 500, only to have the remainder of the year provide a paltry 1.4 percent additional gain. Given last year’s gain of 13.4 percent, the first quarter’s additional gain of 10 percent, the fact that the S&P 500 is up 136 percent from the intraday low of 666 in March 2009, and that stocks have been in a sustained bull market for more than four years, it would not be surprising to see the market take a breather.

With the market at an all-time high, pretty much everyone who owns stocks has a profit at this point. While there are still significant cash balances in 401(k)s and other accounts, a lot of cash has poured into stocks this year, reducing the cash available to drive further gains. With this in mind, investors may want to consider trimming positions and raising some cash going into earnings season.


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