After making new all-time highs in the Dow, S&P, Dow Jones Transportation Average and some Mid-Cap Indexes on Thursday, July 3, the market corrected last week to the downside in order to work off some of the overbought condition that these best-ever levels had created. In the process, many market “experts” and the financial media in particular started to fall all over each other in calling for a pullback. The extent of the correction coming from these naysayers ranged from a nominal one of less than five percent to a full-blown official setback of between 10 to 20 percent.
The evidence offered for such an event ranged from the ridiculous to the sublime, as it was pointed out that this current bull market of 64 months and counting is longer than the 59-month average bull market since 1949. On the other hand, it should also be mentioned that this is only the fourth longest sustained up-move and it is also the fourth largest percentage gain for the S&P as well, which means that we are still within historical parameters. Then the nervous Nellies out there pointed to the fact that we have now gone 34 months without a 10 percent S&P correction and this is now the longest such streak since 2007. Since 1945 the market has gone an average of 18 months between S&P corrections of 10 percent, but there have been longer periods between declines of this magnitude as well. The skeptics also mentioned that this is now the 61st day where the market has moved by less than one percent, but it should be pointed out that in 1995 this type of market behavior lasted for 95 days.
Then we have heard that the price/earnings ratio for the S&P is too high to sustain the ongoing advance. Yes it is true that at an S&P price of 1975 and expected earnings in 2014 of $116 this multiple is around 17, higher than the traditional 16.4 ratio going back to 1954, but on the other hand, interest rates have never been this low for this long a time period. Since bonds compete for investor dollars along with stocks, by this measure equities are certainly not overvalued if earnings can continue to expand.
As was pointed out in last week’s column, when the market reached its highs on July 3, the volatility index, otherwise known as the VIX, reached as low as 10.32. Since it cannot go below 10 and it moves inversely to the stock market, the probabilities of the market going lower get very high if the VIX pushes off of these low levels to the upside.
And this is exactly what happened last week as the S&P underwent its largest weekly decline since April 11 with a total loss of 0.9 percent, which meant a drop in the S&P of a grand total of 18 points from 1985 to 1967. If this is the best that the bearish contingent can do, then it would appear that the overall uptrend is still in place. The small-cap Russell 2000 Index did fare much worse with a 3.9 percent setback, its worst weekly showing in more than two years, but as I have pointed out in previous columns, the total capitalization of this average is too small to affect overall market performance.
After that nominal setback last week, the market began the current week with a vengeance on Monday and as a result, the Dow Jones Transportation Average and the Nasdaq100 Index, which consists of the largest non-financial companies, both reached new record all-time highs and even the Dow Jones Industrial Average attained an intraday best-ever level of 17,088 before coming off a bit at the close. This now means that the market has been higher on three out of the past four days and once again puts the burden on the shoulders of the bearish contingent to prove its case.
The most important economic event last week was the release of the minutes from the Federal Reserve policy meeting in June. It was revealed that some policy makers were concerned that investors may be growing too complacent about the economic outlook and that the central bank should be on the lookout for excessive risk-taking. They expressed concern about the low volatility in equity, currency and fixed-income markets but at the same time “it was noted that monetary policy needed to continue to promote the favorable financial conditions required to support the economic expansion,” which basically means no interest rate increases for a long time. And as long as the market has the Fed at its back, so to speak, any setbacks will be viewed as buying opportunities.
Investors should be aware of the fact that bull markets only end when there is the perception of a recession on the horizon and despite the awful performance of the economy in the first quarter of this year, we are in the midst of a recovery. This was once again proven by the only two economic releases last week which showed that weekly jobless claims continue to decline, now down to 304,000 and May wholesale inventories rose by 0.5 percent. This is an indication that businesses expect new buying to meet the larger supply of goods that are now available.
This week will see 58 S&P components reporting their second-quarter results, and the first major company to release their results was C, which rallied sharply after it beat on both the revenue and earnings line as well. We will also hear from the other large banks, in addition to important technology companies such as INTC, YHOO, EBAY, IBM and GOOG. This group is projected to show the largest earnings gains of any of the S&P components, in the order of 13 percent, and if the large technology companies come through, this is another factor that can give the entire market a good upside lift.
Finally, we will get our first reading on June retail sales, industrial production and housing starts. And in probably the most important event for market watchers, Fed Chair Janet Yellen will testify to both the Senate Banking Committee and the House Financial Services Committee on the state of the economy and the potential for a change in the central bank’s interest rate policy. So there is certainly plenty on investors’ plates this week.
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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