What’s driving the Dow?
- 23 February 2012
While still more than 1,000 points below its all time October 2007 high at 14,164, it had climbed more than 2,000 points since early October and was standing at a level last seen in May 2008, some months before the Lehmans crisis erupted. The tech stock driven Nasdaq was at a 10 year high and there was an advance in the wider-based Standard & Poors 500 taking it to over 250 points higher than October lows.
So a pause for breath was on the cards. There was bound to be some profit-taking – the DJI future was pointing to losses before the opening bell clanged. Markets can't travel one way for ever – there are always downs in bull phases just as bear markets often have more sessions trending up than down.
Besides these technical factors, there is the constant background of the on-off-on-off Greek crisis and, more recently fears over oil prices as the Iranian situation worsens – oil trader Vitol was talking the price up from around the present $120 to $150. One theory is that the Iranians are ratcheting up the war talk, pushing up a barrel of crude to make up for the lower volumes of oil it is now able to sell.
But even with all that, the Dow only slipped a fraction of one per cent in early New York trading.
Progressing despite everything
New York markets seem to have taken another problem in their optimistic stride – less information on first quarter trading as leading US companies issue their 2011 full year figures. It has been customary to include "guidance" on prospects for the early months of the year – many traders, analysts and fund managers depend on this.
This year, however, firms are reluctant to put their corporate heads above water. With most companies in the S&P 500 already reporting figures, only around one in four has ventured firm facts on early 2012 trading – the lowest ratio since before the banking crisis.
"We're seeing a marked reluctance from companies to be concrete in their forecasts," said Christine Short at data provider Standard & Poor's Capital IQ. "When companies have talked about prospects for 2012, they have tended to make generic comments, which could apply to any company in any sector." Companies blame uncertain currencies and commodity prices – while there is an increased nervousness among corporates to offer information in the light of increased insider trading tension.
And even those who have ventured an opinion, more have downgraded expectations than enhanced them.
More bad news – is it in the price?
Backtrack to late last year when Goldman Sachs brought out its customary forecast for the coming 12 months. It was nothing to get excited about. The investment bank's "base case" was:
1. Stagnant economy. A fifth straight year of sub-trend economic growth with 1.6% GDP growth forecast in 2012 and the environment persisting in 2013 with 2.2%.
2. Modest earnings growth. It expected margins to peak in 2011 and fall slightly in 2012. Combined with weak sales growth, this means S&P 500 earnings should grow only 3% to $100 in 2012.
3. Stable valuation. The bank suggests P/E multiples tended to remain flat during 17 "stagnation" periods of prolonged weak but positive economic growth in OECD countries since 1980. This flat valuation along with modest earnings growth translated into a S&P 500 year-end 2012 target of 1250, roughly unchanged from the current level.
The S&P 500 is now trading 1,000 points higher. It seems the bulls now have the upper hand, holding more positive outlooks for margins and Europe. On a risk-on basis, optimists were looking in December for an S& P 1,400 by next Christmas. Goldman rejected this view, expecting the situation to worsen before a possibly half hearted recovery in later 2012.
Driving the Dow
What's going on? Perhaps Goldmans underestimated the lack of new money.
In the UK, fund managers Schroders says that after a decade of de-rating, US equities "look attractive based on current earnings and extremely so compared to bonds (both government and corporate)." It sees "scope for disappointment" but adds that stockpicking companies able to "sustain or grow earnings, together with those able to deliver an attractive dividend return" could give investors a more compelling asset class than cash or government bonds.
Clouds on the near horizon? The Volatility Index (VIX) is low – it could move higher while the Citigroup Economic Surprise Index is in high ground, implying that there might be less unknown good news to push the market higher.
But on the bright side the S&P 500, a broadly based index of US shares, has fallen in only three presidential election years since 1952, according to David Schwartz, the stock market historian.
The index fell 3% in 1960, ( Kennedy elected), 10% in 2000 (George W Bush into the White House) and 38 per cent in Obama's 2008 year when banks imploded. In the other 12 election years over the period, the S&P has risen, seven times by double-digit percentages.
Schwartz says: "I think the US m
arket will rise this year. What's intriguing about America at the moment is that the economy is really coming alive. Last year it was like a spring being pulled tighter and tighter – now the market is ready to rebound. The election will also play a part."
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