Color Me Cautious

 | Feb 15, 2013 | 9:00 AM EST  | Comments
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I am not in the camp that says another recession is coming, even though this can't be ruled out. However, I am in the "Rally making me uncomfortable because it is not supported by fundamentals" camp.

If the S&P 500 manages to have an "average" year of up 9%, it's booked most of those gains already, so the rest of the year could be quite volatile. Keep in mind that, at this time last year, the S&P was up even more than it is now, and the market basically did nothing for the balance of 2012. A pattern is being established: a strong first-quarter rally, then "Sell in May and go away for one to six months," then a year-end rally.

I won't be bullish about further gains outside of this pattern unless fundamentals -- economic statistics or earnings estimates -- start improving more strongly.

S&P Pattern, 2010-2013

In that vein, Goldman Sachs points out that the firm's "Current Activity Indicator" is cooling off, and that upside surprises to economic data have ended. The U.S. economy may not be as "hot" as the stock market had indicated over the last couple months. 

Goldman Sachs Current-Activity Tracker

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Goldman Sachs Upside-Surprise Tracker

Of course, we also see that the eurozone is slipping into recession, which is not helpful for U.S. markets. 

U.S. consumer demand may be set to soften, as well. One driver of consumer spending in the first quarter -- the inflow from tax refunds -- is lagging previous years due to delays in the Internal Revenue Service's ability to process returns, which is thanks to the fiscal cliff. This chart from Piper Jaffray shows the contrast from 2012.

Delayed IRS Income Tax Refunds
Source: U.S. Treasury Department, Piper Jaffray

Bulls are hanging their hats on this massive rotation into stocks. I agree that there were substantial inflows in January, but the trend appears to have tapered off. Investment Company Institute statistics show that only $638 billion went into U.S. equity funds last week, while $6 billion went into bonds and $5 billion into foreign stock funds.

Flow-of-funds watchers need to keep in mind that the massive influx of special dividends at the end of 2012 landed in brokerage accounts, and were probably responsible in large part for the reinvestment into stocks. Between the special dividends, 401(k) matches, year-end bonuses and the like, it was almost inevitable that January would have huge flow of funds. February appears to be going back to a slower "normal." 

Finally, pundits are noting that retail sales look OK. I pointed out early in January that retail sales may have been distorted by people spending their gift cards they received at Christmas. Everyone I know had run around the first couple weeks after the holiday, spending them like crazy. So now the gift cards are gone, and paychecks are perhaps a few hundred dollars smaller due to the 50% payroll tax increase folks are suddenly discovering. February retail sales will be the test as to whether any January strength was real, or whether it was transitory. 

Color me cautious for now. I am not a seller per se, but I am not pouring in now, and I would be a profit-taker on spikes up.

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