This summer has been about as hot as I can remember. When it is this hot, you want to do what a dog would naturally do – slow down, find some shade and take it easy. This reaction is about the only logical explanation for what is happening in the market right now.
Sure, things look bleak; pessimism is as high as it has been since March 2009. Unemployment remains high, growth is stagnant, Europe is falling apart, and the United States seems determined to follow. Everywhere you look there is bad news. But are things really as bad as they seem?
The macroeconomic news has been worse than expected and very well could be worse still, but corporate earnings have held up well. For the second quarter in a row almost 80% of S&P companies outperformed on bottom-line earnings, significantly more than normal. In the long run there are only two things that matter to stock investors, price and earnings. Earnings have gone up and prices have gone down, which has all the makings of a good buying opportunity.
As we had predicted, Q2 earnings came in better than expected and the market got a big boost in July. Then August came around and the market has drifted downwards in a jerky fashion. What is this market telling us? In our opinion it is telling us that it is hot out there and no one really feels like doing anything. August is a big vacation month and volumes are always slow, but this August is on pace to be the slowest since 1999. That is quite a feat.
With such slow volume you tend to get jerky trading and a slow decline in the market, which is exactly what has happened. There is no conviction however, and this leads us to believe you cannot read anything into August’s market action. The pros have taken August off, and until they come back to work we won’t really know where this market is going.
We remain cautiously optimistic. How can we say that in the light of so many poor economic reports? Our optimism is for the equity markets, not the broader economy. It is possible to have poor macroeconomic data and still have positive market results, and we think that is probable between now and year-end. First, as we have already stated, earnings continue to rise while prices have not. Second, corporations are sitting on huge piles of cash and they are starting to use it. Just this morning HP announced a large stock buy-back, and there has been a sharp uptick in mergers and acquisitions, which are good for stock prices even if they are not good for the economy as a whole or unemployment specifically. Finally, where else are the smart investors going to go? The 2.5% yield on 10-year treasuries won’t even cover the typical hedge fund’s management fee, let alone get them over the performance hurdle.
I know it is hot, but fall is right around the corner. So grab some lemonade, get a seat in the shade and remember things rarely turn out as bad (or as good) as they seem at the moment. Football will be starting soon, the pros will come back to work, the market will come back and before you know it we will be complaining about the cold weather.
Chuck Osborne, CFA
Managing Director
