The price-to-peak earnings multiple has advanced to 13.4x as of last week’s close as the equity market cruised to its sixth straight weekly gain. In the absence of earnings results, it was positive macroeconomic figures that boosted stocks last week. The market rallied on the strongest monthly job gains in three years, even though they were substantially weaker than many Wall Street experts had expected. Nonetheless, the trend in unemployment is certainly headed in the right direction and investors took a bullish view of the job gains. Also supporting the bulls case was much stronger than expected retail sales for March, sales at chain retailers rose 9.1% versus the expectation of just 6.3%. Even after adjusting for the extreme weakness of a year ago, these sales results showed further resurgence in the American consumer.
Analysts are nearly uniformly predicting a further rebound in earnings for the first quarter earnings season, which officially gets under way Monday after the close with Alcoa (AA). We agree with those calls as the US economy is in a far stronger place than it was a year ago. However, just because earnings are rising does not mean that stocks will necessarily rise, as expectations are already fairly high. Revenue may take center stage as it will provide a clearer indication of growth than will bottom line earnings results which have been highly influenced by lower costs.
The percentage of NYSE stocks selling above their 30-week moving average has climbed to 81%, which is clearly a bullish stance. The market as a whole is certainly in a bullish state of mind with the economy in recovery mode, but we have a growing sense that the market is lacking conviction. Market-wide volume has been far lower on up days than it is on down days, and insider buying has tapered off from low levels to extremely low levels. In fact, last week corporate insiders bought a paltry $2.1 mln in their company’s stock, the lowest total since the rally began over a year ago. In contrast, insiders dumped $824 mln worth of shares onto the market. Of course, this indicator of management confidence has been consistently wrong as insiders have sold into strength throughout the rally, but confidence in this bearish stance has never been higher than recently.
The fact remains that overall market sentiment is again hitting extremely high levels, and whenever a clear direction of thought emerges we become skeptical of this “conventional wisdom.” Investor sentiment can be tremendously fickle and any number of reasons could spark a sell off. For now, we are advising caution while the bulls are so firmly in control.
The beginning of earnings season is always an exciting time for investors as investment theories are either confirmed or challenged by official results. We are maintaining our view that equities are in a precarious position already pricing in substantial earnings improvement, and sentiment is riding high as well. Adding in the fact that stock indexes have risen for six straight weeks and by far the majority of the last 13 months, a pullback seems highly likely in the coming weeks. The chances of a catastrophic double-dip are lessening as time goes by, but a secular bull market like this one is certainly not immune to pullbacks. We think investors would be wise to slightly underweight their normal allocation to stocks in such an overbought condition, and patient investors may benefit from waiting for a better buying opportunity down the road.
