Thank you Mario Draghi. The president of the EuropeanCentral
Bank has pledged to do whatever it takes to save the euro, and
investors are already feasting on the prospects.
The mere expectation that an even deeper crisis will be averted
has helped kick off a powerful rally here in the United States as
well. On Friday, July 27, the S&P 500 finished at its highest
levels in nearly three months.
Indeed, during the past seven weeks, themarket has been
repeatedly shifting course, staging sharp multi-day drops and then
sharp mini-rallies. Still, the net result is abullish one, as
investors have come to embrace the likelihood that European policy
makers will come up with a fix.
Trouble is, a number of other concerns have popped up, and you
need to keep your enthusiasm in check.
As we head into August, here are five key headwinds that
investors need to keep in mind. Chances are, the investing herd
will fixate on one or several of these factors as we head into what
is typically the slowest trading month of the year.
1. A lacklusterearnings season portends more weakness to
come.
Roughly 60% of S&P 500 companies that reported results have
trailed consensus sales forecasts.
Of greater concern, the ratio of companies lowering their
guidance to those raising it is -6.4%, according to Bespoke
Investment Research. This means that for every 100 companies
raising their guidance, 106 lowered them. That's the lowest reading
since the fourth quarter of 2008. The raising/lowering trend has
been negative for four straight-quarters, after nine
straight-quarters of positive trends.
Unfortunately, earnings season has a few more weeks to run, and
if this trend continues into mid-August, investors may have more
reasons to sell than to buy.
Analysts have started to update their models to reflect the
incipient weakness, but they may not have gone far enough.
"Estimates have come down 3% since the start of reporting season
and 5% since the start of the year. However, consensus still
remains well above our estimates, especially for fourth quarter,"
note Merrill Lynch analysts.
2. The Bernanke option: sell on the news?
Part of the recent market strength is attributable to expectations
that the Federal Reserve is poised and ready to take more
stimulative action. Yet, as we saw with the first-round of
Quantitative Easing (QE1) and again with QE2, much of the gains
from these moves accrued to investors in advance, as many sought to
sell on the news once the actual plan was released. More to the
point, economists now debate whether QE1 and QE2 even helped
theeconomy all that much, other than helping provide liquidity to
speculative assets such as commodities.
3. Is the private sector growing gloomy?
In the past few years, many companies stepped up their pace of
fixed investment, laying the groundwork for the capacity to handle
projected growth ahead. Not anymore. These investments, which
typically spread out throughout many quarters, are showing clear
signs of cooling. If you assume that some of the 5.3%
year-over-year expansion in business-fixed investment is the result
of projects that got the green light six-12 months earlier, then
the net new level of investment may not be growing much at all.
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4. Short-covering may not last
The recent rally may not so much be attributable to bullish
investors wading in, as much asbearish investors wading out. "We
have been making the case that the recent rally was more
short-covering than new demand (buyers). The technical indicators
confirm this with negative divergences in price momentum andmarket
breadth ," wrote Merrill Lynch analysts in a July 30 note to
clients.
As I noted in mid-July, short sales figures had dropped
precipitously at the end of June. And some heavily-shorted stocks
such as
Sprint (NYSE:
S
)
have since posted powerful gains.
Yet, short-covering only lasts so long. If short sellers think
they have proper positioning for this market, then they are
unlikely to provide further ammo by covering positions. Indeed,
these short sellers may have taken a cautious stance until the
ECB's Draghi andthe Fed 's Bernanke have made their next moves.
Once those potential positive catalysts have been unveiled, the
risk for short sellers fades and they may again add negative
pressure (in the form of short-selling to the market).
5.
Arebonds signalingrecession
?
Thebond market is the virtual "canary in the coalmine" when it
comes to expected economic activity in the periods ahead. And it's
hard to avoid drawing a bearish conclusion after looking at the
yields on 10-year and 30-year government bonds.
.gif)
The U.S. economy grew less than 2% in the second-quarter, and
most economists anticipate growth domestic product growth of about
2% in the third and fourth-quarter. But with the looming fiscal
cliff inching closer, a number of businesses have grown cautious
about near-term spending plans. Coupled with the fact that Europe,
our largest trading partner, is showing signs of weakening further,
you have to wonder whether the forecasted 2% growth can even be
achieved.
The word "recession" is not yet making the rounds in circles,
but we are moving closer to what economistscall "stall speed."
Simply put, a recently resurgent S&P 500 and a slowing economy
do not square with each other.
Risks to Consider:
As an upside risk, consumer balance sheets are no longer as
weak as they were in 2008, so a similar retrenchment in consumer
spending as we saw in 2008 may not come to pass. Moreover, signs
are emerging that an increasing number of legislators understand
the potentially dangerous ramifications of the fiscal cliff,
raising the odds that we'll see some sort of bipartisan agreement
to kick the ball down the road.
Action to Take -->
A number of stocks remain quite inexpensive, and if you can ride
out the near-term challenges, then these stocks should be
considerably higher in a few years when the economy is on the
mend.
Still, with the markets and the economy carrying so much risk
right now, it might be wise tohedge your portfolio with bearishETFs
such as the
ProShares UltraShort S&P 500 (NYSE:
SDS
)
or the
Direxion Daily Small Cap Bear 3XShares (NYSE:
TZA
)
.
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.