Diary of a Financier

2q2012 Outlook: Seasonality Fuels More Bullishness Before Correction

In Capital Markets on Wed 11 Apr 2012 at 17:51

The S&P 500 (SPX) analogue to 2011 is holding fast, but I’m adjusting my 2q2012 Outlook.

Regarding the SPX fractal guide, let me pinpoint our progress. In relative terms, we’ve reached the first material shudder in the analogue, which arrived with Japan’s Tohuku disaster on March 11, 2011:

SPY 2011 analogue- as daily momentum nears negative, bear divergence should manifest in a blowoff top; weekly chart threatening bear divergence

In the wake of that earthquake/tsunami last year, analysts started airing two arguments that returned the market to a bullish trend:

  1. US exposure to effected Japanese regions will be minimal.
  2. The subsequent BOJ stimulus and nationwide reconstruction warrants a growth premium.

TEPCO’s Fukushima Daiichi nuclear reactor deteriorated toward a full meltdown over the weeks that followed. American markets rallied nonetheless, until Japanese concerns yielded to a full-blown Eurocrisis. Everyone should be impressed by US economic resolve in the face of these legitimate handicaps. Brimming with liquidity, stock markets have reached new highs.

Back in February, I called for an April 2012 correction:

“…an earnest market correction shouldn’t arise until the first utterance of 1q2012 micro & macro data. Alcoa (AA) kicks-off everything with its earnings release around April 10. By that time, inventories should have just begun their decline from highs, about a month in advance of unemployment numbers rearing their first uptick of the year.”

SPX is down ~3.5% from its recent high, but I want to refine that expectation, because the fundamentals have changed a tinge. In September 2011, the Street forecast 10% year-over-year growth for 1q12 EPS; revised lower to 4.50% in January; then lower still to the current 0.95% expectation. That’s a low bar, especially after a historically warm winter pulled-forward demand into the 1st quarter. Alcoa’s good earnings and an encouraging Fed Beige Book have me expecting more corporate earnings to reflect that fortune. The big question is whether or not it will prompt management teams to confirm/raise forward guidance. Will executives’ outlooks follow the momentum or succumb to “uncertainty” again? The first half of earnings season will feature the former; the second half the latter. Underlying fundamentals feel strong right now, and that perception is a powerful potion. Come late-April/early-May, an erosion in momentum will subject CEOs to a different mouthfeel. Gunshy, they’ll start acknowledging the deceleration: slowing orders, margin pressure, etc.

We’re adding index allocations to ride this rally into a month-end crest. We added to a Russell 3000 ETF (VTI) for more total market exposure. Regarding singlenames, we committed capital to a stake in MGM Resorts International (MGM), which honored strong long-term signals by bouncing off a short-term double bottom. Finally, we’re initiating a position in the broader Consumer Discretionary ETF (XLY) for extra Beta. Referring back to the analogue, traditional safehaven sectors like Consumer Staples (XLP), Healthcare (XLV) and Utilities (XLU) were the outperformers for almost two months in 2011.¹ Discretionary stocks suffered dearly from supply-chain disruptions after Japan’s natural disasters. Today, they’re the biggest beneficiaries of unseasonably good weather, which gets people out of their houses and shopping around.

Regardless of the near-term, Private Inventories are still a central concern, and consumer stocks carry most of this risk. After February’s report, inventories were a month away from historical levels of overcapacity. (The March report is announced April 16.) Chinese consumers have now arrived on the scene, prompting more investment by American conglomerates. Bullish earnings should have the effect of drowning-out minor macro data like inventories, but like I said, the erosion of underlying fundamentals will psychologically affect executives, changing the tone of this earnings season’s denouement.

–Romeo

¹With Utilities getting crushed by energy market conditions & regulators, they’re not a viable source of alpha today. Staples & Healthcare are too safe for a blowoff Beta-rally.

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