Several measures of the market continued to grind toward new all-time highs as the S&P, Russell 2000 Index of small stocks, mid-cap indexes and the Dow Jones Transportation Average achieved their best-ever levels as the political shenanigans in Washington, D.C. over the federal budget and the debt ceiling almost seem like a distant memory (until of course they surface again early in the new year).
As of Monday, the S&P had gained for 12 out of the past 14 sessions and since its most recent lows on October 8, it advanced by six percent in reaching those highs. It is now ahead by 23.6 percent for the year, surpassing its 23.5 percent advance in 2009 and getting closer to the 26.4 percent rise in 2003. What makes this year’s performance more astounding than the other two is that both of them occurred after disastrous market showings in the prior year (2008 and 2002) and were considered a natural upside reaction to an over-reaction on the downside, whereas this year’s gains have followed four prior yearly advances.
The Russell 2000 Index of small stocks has done ever better with a 32 percent gain in 2013 and is ahead for the eighth straight week, which is the largest number of consecutive higher weekly gains since 2003. These smaller stocks get 84 percent of their revenue in the U.S. whereas the Dow stocks receive 55 percent of their sales domestically, and this could foreshadow a period of stronger economic growth next year compared to this year’s estimate of 2.5 percent.
The stock market is also operating under the old “bad news is good news” syndrome once again in the sense that most of the recent economic reports have shown weaker than expected results. Equities have run to the upside with this in the sense that if the labor market is not improving and the economy is sluggish, then the Federal Reserve will be forced to keep on hold any tapering plans for the current $85 billion per month of bond purchases that it is currently carrying out. As of now, the thinking is that the central bank is not going to begin any sort of reduction of the current stimulus measures until March 2014 at the earliest.
The economic reports recently released have shown that the labor market and the overall economy are just sort of chugging along as the shutdown-delayed September jobs report showed only 148,000 new positions were added, which was well below consensus and revealed that third-quarter job growth was well below that of the second quarter. The U. of Michigan Consumer Sentiment Survey fell to its lowest level since late last year, and the September pending home sales report declined for the fifth straight month and also showed the largest drop-off in three and a half years.
The recent appointment of current Fed Vice-Chair Janet Yellen to be the next Fed Chairman when Mr. Bernanke’s term expires in January re-enforced that no-tapering notion because she is credited with being the architect of the current stimulus program and is widely known to be in the firmly dovish camp when it comes to the tapering debate. Of course, she was not the president’s first choice for this position, as he was enamored of Larry Summers, he of the more-prone-to-tighten camp, but the political opposition to his selection within Mr. Obama’s own Democratic Party basically torpedoed that nomination before it got off the ground, so to speak.
And on the day that her nomination was officially announced by the White House, the market underwent a strong rally, which basically shows that as long as the stimulus measures are in effect, buyers will gladly enter the market on any kind of selloff, which is the main reason why the largest decline of the year so far has been only 5.8 percent. This decline ironically came about in late May to late June when Chairman Bernanke first suggested that the Fed might pull the tightening trigger for the first time since these stimulus programs began in December 2008.
Now that we are in the back-stretch for the third-quarter earnings season, the results have come in slightly better than consensus at the start of the month. As of the 251 S&P companies that have already reported, the gains are now projected to be for a final advance of 3.5 percent and for revenues to be ahead by 2.3 percent. Of the companies that have released their numbers, 76 percent of them have beaten the earnings forecast, ahead of the traditional 63 percent that usually do better in this area, while 54 percent have been ahead on the revenue side, which is lower than the usual 61 percent that beat on the sales side.
There have been other factors that have kept the uptrend intact as well, and one that has added fuel to the upside fires has been the influx of money into equity mutual funds, as it was reported that last week $21.4 billion was received, the largest such inflow in nine months. The current price/earnings ratio for the S&P is 15.9 and this compares to the 16.5 level that was reached at the top of the most recent bull market in October 2007. The ratio was an unsustainable 25.7 in March 2000 at the height of the internet tech bubble, so one can argue that this bullish market still has a bit to go on the upside based on those past metrics.
Finally, margin debt (the amount of money borrowed to buy stock) surged 78 percent year over year by the time the market peaked in March 2000 and by 68 percent at the October 2007 high. But it has increased by only 27 percent recently, which means that there is more room for leverage to expand from current levels.
Of course, all of this does not mean that there is going to be further clear upside sailing for equities, as many companies can still be susceptible to downside earnings surprises and the weak dollar because of the low interest rate scenario in the United States could bring about potential inflationary pressures, which could cause the Fed to act sooner rather than later. In the past, such actions have brought an end to stock market increases and investors should be aware of these potential hazards as 2013 starts to draw to a close.
Donald Selkin is the Chief Market Strategist at National Securities in New York, a veteran in the securities industry for 36 years who is widely quoted in the financial media.
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