With the stock market moving above psychologically-important milestone levels, it is useful to assess its next directional move. So it begs the question: Can this 2 ½-month-old rally be sustained going forward?
My answer is: No.
I doubt the rally’s staying power and wouldn’t be surprised if we give back some, if not all, of our recent gains. I see the S&P 500 going back below the 1200 marker in the coming days.
My goal here is to explain this near-term view of the market, and along the way give you a few investment ideas to profitably navigate this environment.
Please note that this is only a very short-term outlook. I am just talking about the coming days and weeks. By year end, I am still looking for positive gains. Yet compared to the turbulence of the last two years, I envision 2010 to be a fairly tame affair, with the major indices up a decent but unspectacular 5% to 10%. I see the year as one of stability and consolidation, both in the equity markets as well as the underlying economy.
That may not sound exciting. But sound investors who pick stocks wisely can still make a very handsome return.
Markets Priced for Perfection
Here are some of the reasons that may pull the market down in the coming days.
- Earnings Growth Expectations Fully Discounted: The earnings growth expectation currently priced in calls for a 21.4% jump in first-quarter earnings. While these expectations are not unfounded, they may not be easy to beat either. I don’t think the market would be pleased if earnings, revenue or guidance only matches these expectations. The market is looking for unequivocal guidance and visibility that is above the current view. Get a stream of such robust reports and sustaining this momentum will be very hard to accomplish.
- Labor Market Concerns: Everybody is talking about a jobless recovery, but how sustainable can the overall recovery be if we continue to have massive labor market slack? We saw the labor market turn last month; how strong and sustainable that trend is remains to be seen in the coming weeks.
- Fed Policy: The Fed has been removing some of the extraordinary measures that it put in place during the downturn. With respect to interest rates, the Fed has been saying for a while that it intends to keep interest rates low for an ‘extended period’. The market is actively engaged in handicapping a timeline for the Fed to raise rates… not exactly an easy exercise. While the Fed is not expected to start raising rates any time soon, they may start to redefine ‘extended period’ in the coming days, which could spook the markets.
- Greece & China: As if these domestic issues were not enough, the market also has to contend with sovereign risk issues and moves by China’s central bank. While fears about the sovereign debt profile of Greece or any of the other so-called PIGS (Portugal, Ireland, Greece, and Spain) have receded to some extent, China remains a major issue. China is trying to control some of the speculative excesses in its real estate sector – in essence it is trying to let the air out of a bubble without actually pricking it. China’s ability to pull that off without damaging its economy is far from certain and remains a key risk factor for the global economy.
Most of these issues are expected to be with us for a while. They may not be sufficient enough to derail the underlying economic recovery, but they will nevertheless cap any further near-term gains in the market.
How to Make Money in a Range-Bound Market
It is easy to make money in a bull market – everything goes up, including the lowest quality and riskiest stocks. But don’t let the market’s rising tide lull you into believing in the invincibility of your stock-picking prowess. That is one trap that you need to be aware of in this market environment.
You don’t need to be a professional to make money in this market. But make sure you understand that what worked last year is pretty much of little value at this time. You can still find winners out there, but you need to do a bit more due diligence to identify them.
While such winners have many attributes, three really stand out – Earnings Growth, Quality, and Valuation.
1) Earnings Growth: The most important attribute of a winning stock is its earnings growth profile. But just plain vanilla earnings growth is not enough to push the stock price higher. The stock’s current price already captures the anticipated growth prospects. It is more about the potential for the stock to grow ABOVE current expectations that really make the stocks soar. The Zacks Rank helps you capture this key growth potential attribute. At any given time, stocks with a Zacks #1 Rank offer the best earnings growth profiles leading to clear outperformance.
2) Quality: Here I am referring to the quality of the company’s product/service, financial health and management. You want to invest in companies that enjoy a competitive advantage in its market, are in strong financial health and are led by a proven management team. These elements greatly increase the odds of success with your stock holding.
3) Valuation: If all the positives about a company are out there in the market, then you may have already missed the bus. How can you tell if that is the case? Looking at the company’s valuation multiples, such as price-to-earnings (P/E) or price-to-book (P/B), and comparing those to its peers should give you a good idea of relative valuation. Buying a quality stock at a discount to its peers is one of your best bets to insuring a market-topping return.
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Best,
Sheraz Mian
Sheraz is the Director of Research at Zacks. He oversees all the stock analysts who provide insights and stock reports through Zacks Premium.
