European stocks were quite weak this week, dragging down U.S. stocks, but the recovery that began in early October appears to remain intact. Here are how the models look as of this evening:
Top 20 caught a break - didn't we deserve it? SYNO's 50% surge helped a lot, as we would have given up a little ground otherwise. Stocks in the model were all over the place, with two stocks besides SYNO positive but 8 down by more than 5%. We fell 1.3%, while the S&P 500 fell 2.8%. Beyond SYNO, we had several stocks rally but a few plunge. So far this quarter, we are lagging by 1.2%, but we are ahead of the S&P 500 this month by 1.4%.
Conservative Growth/Balanced had a challenging week. Our stocks lagged a bit, and bonds rallied (we are underweight) while stocks fell (we are overweight). For the week, we declined 2.3%, while the stock/bond index fell 1.5%. So far this quarter, we are now about 0.25% behind the benchmark, though we maintain a marginal advantage for the full year.
Sector Selector ETF lagged a bit this week, hurt by the exposure to Financials and Emerging Markets. For the week, we declined 3.8%, while the S&P 500 fell 2.8%. So far this quarter, we are substantially ahead of the S&P 500 (9.3% vs 8.4%).
Market Outlook
Gold collapsed this week as the dollar rallied slightly against major currencies, declining the first four days of the week before finding its footing today. Interest rates remain depressed here and in Germany. Taken together, we can assume that expectations are becoming somewhat more negative about economic outlooks following last week's Euro summit. Recall, there was no money-printing or leveraged bond-buying bazooka fired, leaving investors feeling, for now, that European bond rates may remain elevated. My take is that this is more of the same. The European Central Bank and the Germans don't want to play their cards now. First, they want to extract progress on more tightly aligning the EMU fiscally.
While we are down slightly this month and this year, the U.S. market is the best among major economies. I have been hopeful that investors will soon begin to accept that there are big concerns but that they appear to be more than priced in, but it's hard to get confident about the very near-term. Today was the quadruple options expiration, and there is unlikely to be a lot of volume over the next 9 trading sessions to end the year. I do expect that some beaten-down stocks may attract some investor attention, but this type of thing sometimes happens after the calendar turns.
My technical view is that the market endured a sharp correction. This is definitional though, as technically we may have hit a bear market while Europe and many other markets certainly triggered the official "bear market" with declines in excess of 20%. Our market is clearly in a rally mode since early October. Further, we had a big test a few weeks ago and are now comfortably (well, not exactly "comfortably" but still somewhat) above the lows set in late November. While this may not be apparent, this type of formation prevails around the world. Yes, Europe, the epicenter of financial woes, put its lows in early October, rallied, retraced and is above the late November lows too. I believe it is important to watch the European stocks (and the currency). Their stocks are down more than ours, but they are showing a similar pattern of a good low having been set earlier this quarter. Further, for all the concerns about Europe, the Euro has declined only 2% this year relative to the dollar.
Tying it altogether, I have no change in my views. Stocks are very cheap, reflective of fundamental challenges that are quite prevalent but also well known. I think sentiment is almost as bad as it was in early 2009. I view the technicals as favorable. I was too optimistic this year for sure, as I had expected the market multiple to move to 15X from 13X on $100 projected 2012 EPS. The 2012 projected EPS are indeed $100 a year later (actually $107), but the multiple currently is closer to 11.5. As I look out, we could see some big and seemingly unexpected improvement in the employment outlook. Already, initial claims have dropped sharply. The potential changing of the guard (or the reaffirmation, if I am correct, with Obama somehow pulling off reelection) could prove to be a catalyst for sentiment too. My forward outlook entails an expansion of the PE to 14X but on projected 2013 EPS of $110. This works out to 1600. My expectation is that the current 2012 estimate of $107 is probably too aggressive, and we will need to contend with that in the first couple of months of the year as companies report Q4 but also project 2012 outlooks. My guess is that lower earnings are priced in - that's why we are down from April by over 10% still.
One final thought on my outlook is that smaller companies should continue to attract potential M&A activity. As long as the headwinds are going to keep blowing, which is likely, larger companies, starved for growth, will continue to try to buy it. A second big driver for smaller stocks will be improved investor sentiment. Small stocks suffered in 2011 as soon as the market turned in early May and liquidity began drying up. It's not always that market direction dictates the relationship between big and small stocks, but that is the dynamic these days.
Articles
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Regards,
Alan Brochstein,CFA
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