Market Treads Water as the Fourth-Quarter Earnings Season Gets Underway

Despite new all-time highs reached in the early part of 2014 by the S&P, the Russell 2000 Index of small stocks, the mid-cap indexes and the Dow Jones Transportation Average, for the most part the major averages have gone nowhere so far with more than half of the month of January finished including the federal holiday that closed the financial markets this past Monday.

With the first installment now underway in January of the $10 billion a month tapering of stimulative bond purchases out of the current $85 billion a month and reports giving evidence of an economy starting to show signs of a better recovery, investor focus has now turned to the fourth-quarter earnings news, which has been good in some instances so far and disappointing in others.

Economic reports that have shown that the economy is improving included December retail sales excluding autos rising by more than estimated at a gain of 0.7 percent while the so-called “control” group that excludes autos, gasoline and building materials and most closely matches the consumer spending component of G.D.P. also increased by more than expected as well. The January New York State Empire Manufacturing Survey rose to its highest level in 20 months, the Fed Beige Book of economic activity in various districts of the country showed that there was “moderate economic growth helped by consumer spending, an improving labor market and strength in manufacturing,” the January Philadelphia Fed Manufacturing Index increased, December housing starts concluded the best year for the industry since 2007 and December industrial production rose for five straight months, which was the best showing in three years.

For the 30 S&P companies that have reported so far, the scorecard reads as follows: only 48 percent of them have beaten on the earnings side versus the traditional 63 percent that usually report better than expected profits; while on the revenue side, 60 percent of the companies have beaten, which is better than the traditional 55 percent that do better on sales. The projected earnings gain for the S&P during the final three months of 2013 is expected to be 5.9 percent and sales are predicted to be ahead by 1.8 percent. Companies whose shares have done better after their reports include Dow component AXP in addition to BAC and MS. On the other hand, stocks that have sold off after their reports include Dow components GE, GS and INTC, in addition to retailers BBY, BONT and LULU, plus financial corporations such as C and COF. The next three weeks will see the bulk of companies reporting, with over 300 S&P components stepping up to the plate to give their results. By then we will have a much better idea of how earnings did during the fourth quarter.

In looking ahead to 2014 and how the market could perform after its historic gains in 2013, let it be pointed out that stocks have advanced two-thirds of the time in the year following one in which the S&P was ahead by more than 25 percent. Equities  do better 50 percent of the time following two years of double-digit gains such as we had in 2012 and 2013 at 13.2 percent and 29.6 percent respectively. The average market gain in a year following an advance of more than 25 percent has been 6 percent and 2013 was the eighteenth time that this has happened.

There have been 25 occasions since 1975 when the month of January ended higher and the market advanced for the year 23 such times. In the 14 years since 1975 when January is lower, as it is at present, the market has nonetheless managed gains in 8 of those years.

The current bull market that began in March 2009 is now 56 months old and is ahead by 165 percent. However, this is only the sixth longest bull market since the end of World War II. The longest and most profitable was the 113 month advance between October 1990 and March 2000 when the S&P rose by 417 percent. June 1949 to August 1956 saw gains of 266 percent over those 86 months. The August 1982 to August 1987 60-month advance recorded a 229 percent gain, which means that the current up-move is not extended by any historical measure.

It is projected that Gross Domestic Product will gain 2.6 percent in 2014 and the S&P has gained during 93 percent of quarters in the past 35 years when G.D.P. growth was between 2.5 and 3.5 percent. This growth, which will be an improvement over 2013’s 1.7 percent, is expected to be a function of wage increases of 3 percent outstripping inflation of 2 percent, an ongoing improvement in the housing market with new home sales expected to gain 16 percent and a narrowing of the U.S. trade deficit as American exports rise by 4 percent.

Finally, the market usually does well after the easiest money dries up as it already has, due to the increase in government bond yields since the Fed announced its intention to begin the tapering process but before the central bank starts to tighten policy, which it says it will not do until late 2015. It could raise the federal funds rate at that time from its current record low level of between zero and one-quarter percent.

As comforting as these statistics are, there are no guarantees in investing, which means that there could be certain scenarios that would play havoc with the market’s probability of advancing further in the next 12 months. The one threat that has always ended bull markets in the past is that of rising interest rates, which could occur as the Fed brings its tapering program to an end by this October. On the other hand, if central bankers see this occurring, one would have to assume that they would lessen or even halt the reduction of stimulus in order to push rates lower once again.

There is also the threat of some unforeseen event, such as a debt default by Puerto Rico, which has the third largest amount of debt outstanding after California and New York despite a much smaller population and less of an ability to tax. And there is always the possibility of another European debt or banking situation getting out of hand as well, as we have seen the past couple of years with Cyprus and Greece as the primary bad actors.


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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