The Day Ahead: Umm?

 | Jan 22, 2013 | 8:00 AM EST
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When wondering if the rally can continue, ponder these nerdy market stats.

  • Dow Jones Industrial Average price-to-book ratio current: 3.61x
  • Five-year high: 4.13x (February 2010)
  • Dow Jones Industrial Average dividend yield current: 2.55%
  • Five-year low: 2.38% (February 2011)
  • Defensive stocks are in the bottom quartile of performance in the last three months (screams portfolios are now too overweighted in cyclicals, meaning valuations have gotten excessive).

To borrow, but not infringe upon, the words of Jay-Z, "welcome back." I truly hope you were able to take in the abundant amount of rich U.S. history on full display. From Martin Luther King, Jr. Day to the president's inauguration, we, as a country, have come a long way and it's unfortunate that powerful message gets lost amongst concerns on an Apple (AAPL) quarter.  Yours truly spent the day doing two things: (1) digging up black and white photos of inaugurations gone by for inspiration and (2) deeply analyzing the market's middle-finger rally, (a perfect description since the rally has unfolded amid a sea of viable negativity). 

Top question is whether the party will continue to grow in numbers or abruptly cut out at midnight. Unfortunately, the answer is not so easily determined, especially as the DC toast-givers have decided to forestall (hopefully) a day of reckoning with the fee-based ratings agencies.

Here's why I feel so emotionally torn:

  • The market's advance suggests base cases on the economy and earnings estimates for 1H 2013 are overly conservative. But can that be believed amid the fiscal drag that is failing to be acknowledged, though is darn sure occurring beneath the surface of euphoria?
  • The market has sketched a portrait that growth in 2H 2013 will be meaningfully improved relative to 2012, 1H 2013 and the disappointing post-recession norm. In this zone, which is GDP growth north of 2%, companies return to raising earnings guidance because revenues have reaccelerated and costs remain structurally lean. Win win, right? That's the gospel according to the market.
  • I really hate using the word "resilient" when describing the market as it's pretty lazy terminology. But this one time I will make an exception. The market has, so far, not reacted harshly for an extended period to any dreary December/early January macro data. The same could be said for the topic of earnings, which in my opinion have taken a turn for the worse. So, with this type of inaction in plain view, I suppose it's okay to predict smooth sailing (as in no dreaded 5% pullback inside of five trading sessions) even as real underlying economic weakness smacks us in the face. If the market has not giveth, why predicteth.

Rest assured that to utter what I just did is of mild concern and in my head sounds absurdly complacent. Luckily, according to an informal poll I ran on Twitter, people are not compelled to borrow money to buy stocks. That's somewhat reassuring. Nonetheless, I don't feel particularly pressured to churn and burn stock ideas. In fact, I advise greater selectivity at these valuation levels (valuations in certain sectors, for example transports, are reaching points where good news could lead to selloffs) as the strong names will withstand a minor pullback, whereas the beta that was chased is dumped.

Also, stay away from JC Penney (JCP) here. The trading action in the stock hints at an impending negative news event.

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