I laid out two theories relative to the markets going forward this week and we are working through the first one now with a quarter end rally as a potential upside trade. The other is a downside move the second half of the year if the outlook doesn’t improve. I have receive several emails and comments related to the second half of the year and thought it would worthwhile to explore what are the issues to watch and the impact on the markets. Remember these will take time to unfold and they are not predictions relative to market direction now, but over time will have an influence on how the markets play out.
Europe is the biggest and brightest of the issues facing investors. The day to day volatility has been evident, but it is the longer term impact that is the concern. The summit taking place over the next couple of days is just another news event, what the EU does going forward is the key. They must have a plan of resolution to the current debt crisis relative to funding and potential power grab that will result. If the plan doesn’t unfold the longer term impact to Europe will be restructuring and a deep economic recession. The impact to the US and China will be significant as they are a big part of both economies. Thus, Europe is a trade short term, but longer term this may become a great short opportunity. Let in unfold and for those of us who are patient big opportunities will be presented in either direction.
The US economic picture lacks any clarity beyond what is being reported this week. The outlook for the next six months lacks any confidence relative to projections. In the fourth quarter of 2011 I wrote about the earnings projections for 2012 falling to single digits for the first time since the 2008 financial mess. The projections for 2012 were 8.9% growth relative to the S&P 500 companies. I received plenty of comments about that during the first quarter as stocks rose nearly 10%. The interesting part was Q1 earnings for the S&P 500 grew 8.3%, less than expectations coming into the year. As we end Q2 this week, the projections are only 6.1% growth for earnings on the S&P 500 index. We are going the wrong direction for growth! This is a major point of concern looking forward. The data has to improve month-over-month if stocks are going to build a sustainable uptrend. The same old saying keeps coming to mind, “it’s the economy stupid!” This is another area that in time will present opportunities.
The consumer is the momentum of the US economy. We have noticed a slowing in spending and the retail stocks are starting to reflect the slowdown. One area of note is the leisure sector and specifically the restaurant stocks. Darden revised their forward guidance with a drop in Olive Garden and Red Lobster sales. Chipotle dropped 6 % on Wednesday. The issue is jobs, Europe, China, etc. The only thing that has really gone the consumers direction of late is the decline in gasoline prices. This is a trend to watch looking forward. If consumer spending continues to fall the impact to stocks will be similar.
The longer term outlook relative to the economic picture isn’t pretty. In fact, it has many, me included, worries about the sustainability of growth in the US, Europe and Asia. A global recession has been predicted for the last two years, but has not materialized. The money pumped into the system from the central banks has kept that from becoming a reality. The question going forward is how much more can the central banks do to keep it from becoming a reality. Growth has not taken root from all the stimulus. First quarter GDP revisions are out today and the hope is for them to move back above 2%. Wow, we are hoping for a 2% GDP growth for Q1 when it was estimated to be closer to 3%. We can keep trying to put lipstick on the pig, but sometimes you just have to admit it is still a pig.
The focus of this post is not to be negative, but to point out the longer term view of what is developing. Those developments will swing based on the short term news, but in the end they will define the longer term trend for the markets. The weekly chart for the S&P 500 index is still in an uptrend long term. A break below the 1260 level would break the trendline and the issues above could all add up to the catalyst to break the trend. If they do we should be ready to take advantage of the resulting opportunities.