Wall Street Week Ahead: A nice rally while it lasted

NEW YORK: At the start of the historically weakest month for
equities there are plenty of reasons to believe stocks may be just
about reaching a top - at least in the short term.
The S&P
500 has surged 14 percent this year and is at its highest level in more
than 4 years. Not counting 2009 when equities rebounded from their
crisis lows, this could be the best year for stocks since 2003 - nearly
a decade.
A report showing hiring in the United States in August
was again much slower than expected and warnings of a slowdown at Intel
and FedEx this week, which will likely foreshadow a very weak earnings
season, have not been enough to deter investors buoyed by aggressive
central bank action.
After the European Central Bank's
pledge to buy the debt of troubled eurozone countries this week the Fed
is widely expected to introduce new stimulus measure in the form of
more bond buying when it closes its two-day meeting on Thursday.
"Good
news in good news and bad news is good news, largely because of the
Bernanke put," said Eric Kuby, chief investment officer, North Star
Investment Management in Chicago.
The S&P 500 is now trading
at 13.3 time its forward earnings estimates, meaning investors are
willing to pay just over $13 for a dollar of expected earnings from
S&P 500 companies.
Although that is below a median forward price-to-earnings ratio of 13.7 since 1976 - according to Morgan Stanley
- it is close to the upper end of the range in the low-growth post
crisis era of the last 5 years. During that time there has been a
median price-to-earnings ratio of 12.9, according to Thomson Reuters data.
In
fact, the recent price-to-earnings high was 13.5 in February 2011, just
above current levels. If you are of the view that little has changed
since then, there is no reason for the ratio to go much higher. That
combined with a slowing earnings picture inevitably means lower prices.
"Our view is that the next double digit move in the market is down not up," said Morgan Stanley in a research note.
The
analysts, led by equity strategist Adam Parker, believe the S&P 500
will finish the year at 1,214, 15 percent below where it is now.
At
current levels the risk-reward skew is starting to look less attractive
then it did. That is especially true given the uncertainty the November
presidential elections are likely to generate, as well as the potential
for more slip-ups in Europe.
"We put a 1,450 target on the S&P for year and so I'm encouraged," said Jack Ablin, chief investment officer at Harris Private Bank
in Chicago. "But I will say, if this trend continues, I'm inclined to
declare victory and move to the sidelines (and) start taking profits."
The
average analyst estimate for the S&P 500 this year is 1,383
according to a Reuters poll from the middle of the year. That shows
Ablin is not alone. The S&P's performance has already outstripped
most expectations.
Another negative factor is the rapidly
declining earnings outlook for the remainder of the year, as well as
for 2013. Analysts are now expecting a 2.1 percent drop in third
quarter earnings year-on-year. About a year ago they were looking for
growth of nearly 15 percent.
This week Jonathan Golub, UBS's
chief U.S. equity strategist, cut his S&P 500 earnings outlook due
to a weaker U.S. economic outlook, conversion distortions from a
stronger dollar, as well as weaker oil prices.
For 2012 Golub cut his S&P earnings forecast to $102.50 from $103.50 and to $107.00 from $110 for next year.
Golub
believes third quarter earnings will be just $25.10, 2 percent below
the same period last year. On an annualized basis that would translate
into an S&P 500 level of just over 1,300 given a price-to-earnings
ratio of 13.
Signs are that those forecasts are already starting to come true.
On Tuesday, FedEx Corp ,
the world's second-largest package delivery company, cut its profit
outlook for the current quarter, saying weakness in the global economy
was hurting demand for overnight international shipments.
Three days later, Intel Corp
cut its third-quarter revenue estimate due to a decline in demand for
its chips, as customers reduce inventories and businesses buy fewer
personal computers. A revision of Intel targets had been expected by
some analysts after PC makers Hewlett Packard Co and Dell Inc warned of slow demand last month.
Golub is now talking about an earnings "drought" and even an earnings "recession."
"While
investors are focused on monetary policy, we believe these weak
earnings results will contain a market advance," he said in a research
note.
Golub has a year end S&P target level of 1,375, 4.3 percent below Friday's closing level.
The
latest leg of the rally was a 2 percent surge on Thursday that pushed
the S&P 500 to its highest in more than four years and the Nasdaq
to its highest in 12 years.
The move was courtesy of the
European Central Bank and its pledge to act as an unlimited lender of
last resort to troubled European nations. But it is not a done deal.
The
German constitutional court will rule on Wednesday whether the European
Union's new ESM rescue fund should come into being. If it vetoes it,
the ECB's plans could be left in tatters since its intervention
requires a country to seek help from the rescue fund first.
Dutch
elections on the same day look to have been robbed of some of their
potential drama, with the hard-left socialists now slipping in the
polls. Instead, the fiscally conservative Liberals are set to win most
seats with the center-left Labour party also polling strongly.
But
there are no guarantees and Germany could yet be robbed of one of its
staunchest pro-austerity allies in the debt crisis debate.
"While
we got some monetary solutions we still need more answers (on) the
underlying European economy," said Ablin. "I don't think bond buying
solves the euro crisis."
Europe is not the only concern for
investors. A slew of Chinese data on Sunday will provide an insight
into how the world's second economy is faring amid concerns of a
slowdown. The data includes inflation, retail sales and industrial
production.
The Baltic Exchange's main sea freight index
<.BADI>, which tracks rates for ships carrying dry commodities,
fell for the eighth straight session on Friday. Some of the weakness is
blamed on collapsing iron ore demand from China.
Shipments of
iron ore account for about a third of sea-borne volumes. Spot iron ore
prices just hit their weakest in nearly three years, extending a market
rout that began in July, while Poor demand drove Shanghai steel futures
to a record low this past week.
But even with the less than stellar fundamental picture, the old saying 'don't fight the Fed' has proven to be true once again.
The
chances of the Federal Reserve embarking on another round of bond
purchases next week have jumped after the disappointing August U.S.
employment numbers on Friday, according to a Reuters poll of economists.
The
median of forecasts from 59 economists gave a 60 percent chance the Fed
will announce another round of quantitative easing, or QE3, on Thursday.
For
the last 40 years the MSCI world index <.MSCIWO> has lost 0.9
percent on average in September, making it the worst performing month
for the stock market, according to data from Thomson Reuters. So far
the index, a broad measure of global equities, is up 2.6 percent this
month.
This year may well buck the trend. - Reuters