The stock market has been somewhat fickle this year, like the spring weather: sunny and clear one moment with thunder heads blowing in the next. For the month of May, stocks returned 2.1% continuing a recent string of positive monthly returns, after a balky January. Prices are up 9 of the last 12 months for a rolling 12 month return of 20.4%. And yet it’s curious how many investors don’t seem to be feeling it: Spring is in full bloom, yes it is.
The “seasonality” factor may be influencing investors’ collective mindset. Stocks tend to move sideways during the summer months, so many may be braced for pending disappointment. Data compiled by Bespoke Research over the last 10 years shows stocks earning a slightly negative return between May 31 and August 31. Defensive stocks tend to be the highest returning and cyclical tend to be the lowest. Financial and industrial stocks in particular seem to be the most out of favor during the summer time.
Or possibly, weak economic data may be fueling skepticism. The terrible GDP figures for the first quarter make one question whether or not the S&P 500 can actually meet earnings projections for the year. Q1 GDP figures were the lowest (negative) we’ve seen in several years. This will place more pressure on earnings expectations for Q3 and Q4, when the lost ground is expected to be made up.
Earnings, in my opinion, are the backbone of stock prices. The valuation and sentiment of the market have to synch with expected earnings for prices to rise. Earnings were hurt by the weather this past winter and are expected to grow 5.4%, 9.5% and 10.1% in 2Q, 3Q and 4Q 2014, according to FactSet Research. Consensus earnings for the S&P 500 are $119.2 (PE 16.35x) and $132.6 (PE 14.70x) for calendar year 2014 and 2015. While the market has been chugging along, and may be ready for a pause, these numbers are supportive of further price appreciation.
Although much of the data coming across the airwaves is confusing, there are clear positives. Consumer confidence is rising. The job market is continuing to improve. And these two factors are bolstering investor confidence. Individuals have been hesitant but institutional investors are bullish. The S&P 500 is touching new highs, and investors may be feeling like they don’t want to miss out. If this sentiment shift continues it could activate investors currently on the sidelines causing prices to continue higher.
The housing recovery also looks to be in place. Year over year price changes measured by the S&P/Case-Shiller Home Price Index have bumped up dramatically in cities across the country. (San Francisco 20.9%, Miami 16.1%, Atlanta 15.6% and Detroit 15.6%) The age of the average house has never been higher. And, as I mentioned last month, with housing (both to rent and own) on the rise, stocks derivative of the housing industry are well positioned for continued growth.
Technology, biotech and other high growth industries, measured by the Nasdaq Composite, turned down sharply in early March and gave up a good 14% before finding their feet in mid-April. This was enough to give many a real scare. Over that same period, the broad market barely budged, with the S&P 500 down only 2%. In my opinion, the growth to value shift we saw was simply head fake by the market to scare investors into jumping out of favored growth names. My expectation is investors will be rewarded by the growth names as we patiently wade deeper into the year.
On the fixed income side, bonds have surprised everyone this year. Talk was that yields were on their way up, so prices had to come down. Instead, the reverse has happened. During the first 5 months of the year, the yield on the US 10-year Treasury bond has fallen by over 0.5%. To me it’s frustrating when fixed income managers, hungry for yield, are adding high dividend yielding stocks to their portfolios, not a strategy I endorse. The potential implication here is that the growth many have been hoping for is simply not coming. Higher yields across the yield curve are better for investors, longer term, in both stocks and bonds. This is something we will have to keep an eye on.
Most categories of stocks are having a solid year, at the moment. This makes owning them pleasurable, but a bit of a challenge when we are looking to put new money to work. So, we are doing our best to be patient. Please do not hesitate to call, and again, please enjoy the May flowers.
Bruce Hotaling, CFA