Chris Versace and Lenore Hawkins are co-portfolio managers of Growth Seeker, a model portfolio designed to identify large-cap stocks while they are still small- and mid-caps. The following is a free preview of their weekly commentary on markets and portfolio strategies.
The big news for the markets last week was the more hawkish tone in the Fed's FOMC meeting notes released Wednesday, which led to a 1% drop in the S&P 500 soon after the minutes were released. If you missed our take on it, you can read it here. Bottom line, we think the market got a bit too focused on the hawkish bits and ignored the caveats. Nothing says hedging like a lot of "ifs" and "potentials."
The past week was once again quite a rollercoaster. The S&P 500 increased nearly 1% Monday, only to fall Tuesday, erasing most of those gains during one of the worst days in over a month, a move that was likely exacerbated on news that famed investor George Soros reportedly had doubled his put position in the S&P and increased his gold holdings. Wednesday the exhausted markets closed relatively flat, while gold and Treasuries took it on the chin. On Thursday, the markets trended down early from the more hawkish Fed meeting notes, but gained back some ground later in the day, with the S&P closing 0.4% lower and the Russell 2000 down 0.7% for the day.
Stocks closed off their daily highs on Friday, leaving the S&P basically flat for the week, up 0.2%, and 0.3% higher year to date. The Russell 2000 ended the week down 0.7%, and is 3.6% lower so far for 2016. The Dow Jones Industrial Average experienced its fourth consecutive down week and is essentially flat for the year at +0.4%.
The S&P and Dow have both dropped below their 50-day moving averages for the first time since December 2015, while the Russell 2000 is now below both its 50-day and 200-day moving averages. In our view, this suggests the recently returned market volatility is not over.
Of the 95% of companies in the S&P that have reported first-quarter equivalent results, 71% have posted earnings above their mean estimate, exceeding the five-year beat average of 67%, which sounds pretty good, until you realize the blended earnings decline so far is 6.8%. (Blended means taking actual for those that have reported and combining it with expected for those who haven't yet reported.) On a positive note, the fall in earnings so far is not as bad as the 8.8% decline expected at the end of the March quarter. Still, this is the fourth consecutive quarterly year-over-year decline in earnings, which was last seen from 4Q 2008 through 3Q 2009. Only four sectors are reporting year-over-year growth in earnings, led by Consumer Discretionary and Telecom Services.
Looking at revenues for S&P 500 companies in 1Q, 53% have reported sales above expectations, which is below the five-year average. The blended sales decline for the March quarter is 1.5%, but unlike earnings, the decline so far is actually worse than the 1.0% expected at the end of March. Only four sectors have reported year-over-year revenue growth to date: Telecom Services (11.2%), Health Care (9.2%), Consumer Discretionary (5.9%) and Consumer Staples (1.8%) -- hardly what we would call growth verticals. Financials revenues were flat for the quarter and the rest are in negative territory: Industrials (-2.3%), Information Technology (-5.1%), Materials (-8.5%), Utilities (-10.5%) and Energy (-29.4%).
The degree to which companies have been surprising the market (4.2%) is right in line with both the one-year average and five-year average. What is unusual is that the market has rewarded beats less than average while punishing misses more than average, which to us seems reasonable given that expectations were already set pretty darn low.
Eleven stocks in the S&P 500 experienced drops of 10% or more in response to their earnings, while 43 stocks increased more than 5%. The average stock that has reported has fallen 0.05% (so really no reaction) on its earnings day, but then gone on to decline another 1.5% after that. Even more important, the average stock that has missed estimates has fallen 3.4% on its earnings day, then fallen an additional 1.5% in the days following. Stocks that have beaten estimates have enjoyed an average initial bounce of 1.6%, but then fell an average of 1.4% in the following days. So whether a company missed or beat, their stocks fell roughly the same amount post-earnings day, highlighting the degree to which market sentiment is currently overriding individual company fundamentals. We would characterize that sentiment as skeptical, if not concerned, about the outlook for both the global economy and earnings expectations for the coming quarters.
Investor sentiment is particularly wary now as nearly half of investors surveyed by the American Association of Individual Investors report neutral sentiment. This is understandable as it is hard to have a strong view when macro forces driven by bureaucrats have easily taken precedence over economic or company fundamentals.
It isn't just individual investors that are feeling skittish, though, with fund managers pushing cash levels up to 5.5%, nearing the 15-year high of 5.6% during the February swoon. At the same time, given hedge fund performance in 2016, odds are the market will feel the influence of additional redemptions.
Looking at the June quarter, 72 companies have issued negative guidance with 30 issuing positive. The forward 12-month P/E ratio for the S&P 500 is 17.2 based on the forward 12-month EPS estimate and Friday's closing price, which is higher than the five-year (14.5) and 10-year (14.3) forward 12-month P/Es. So far, analysts do not project earnings and revenue growth for the S&P 500 to return until the September quarter.
We view the projected 13% increase in earnings for the S&P 500 companies in the second half of 2016 compared to the first half as overly optimistic. We believe that much like we've seen thus far this year, those expectations will be ratcheted lower over the coming weeks.
Next week we'll hear from 13 more S&P 500 companies. The trailing 12-month P/E ratio for the S&P 500 is 18.2, which is higher than the five-year average of 15.6 and the 10-year average of 15.8. Investors are rightly cautious with a market that is rather richly priced, but we've seen that shorting this market takes some serious intestinal fortitude as one or two sentences from a central banker can get those algo traders giddy and once again we are off to the races, regardless of the economic or corporate fundamentals.
Looking back at prior earnings recession periods, we see that from 1986-1986 the S&P 500 experienced six consecutive quarters of negative earnings outside of a national recession. From late January 1986 through to the market's peak in August 1987, the S&P gained 65%. By mid-October it had lost about one-third, but nevertheless, an earnings recession clearly doesn't guarantee a crashing stock market.
Nevertheless, this time we find ourselves searching for any reasonable catalyst to propel valuations higher. The reality is that today monetary policy has proven relatively ineffective in getting the economy moving with more vigor. The problems are primarily structural in nature, which means that in the middle of a highly contentious and polarizing election cycle, uncertainty rules. This is likely to be a market that ebbs more than flows, so patience and risk management need to be front and center.
Against that backdrop, continued retailer woes, initial weak industrial data for May, the looming Brexit vote and potential for another round of Greek tragedy, we remain in a cautious stance with the Growth Seeker portfolio even with our new thematically driven focus. We would note that not all companies are suffering like Macy's (M) and other department stores, while others like Gap (GPS) are seemingly realizing the precarious situation they are in as its CEO openly floated the idea of partnering with Amazon (AMZN). We see this as the latest round of creative destruction tied to our Connected Society investing theme, and we continue to favor Amazon shares.
Be sure to mark your calendar for our next Growth Seeker webcast on Tuesday, July 7, at 11 a.m. ET. More details to follow, and again we've got some great stuff to share. As we get closer, feel free to email us any and all questions that you may have.
Please follow us on Twitter @GrowthSeekerTST, and keep those questions and other comments coming.