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VERSACE: Rising uncertainties dampen market returns

- - Thursday, May 10, 2012

ANALYSIS/OPINION:

After one of the strongest first quarters for the stock market no matter what index you prefer — the Dow Jones industrial average, the Standard & Poor's 500 index (my preferred metric) or the Nasdaq — April had the distinction of being the first down month for the stock market since November.

So far in May, that downward trend has continued, fueled by rising uncertainty. And if there's one thing the market abhors, it's uncertainty. The culprit has been a combination of several factors, most of which point toward slowing global growth and new questions raised by the recent elections in Greece and France.

Slowing growth in the U.S., Europe and China, the increasingly feared fiscal cliff Washington faces at the end of the year, and what might be called the "known uncertainties," from rising health care costs and shifting tax rules — all are taking their toll. The election results in Greece and France as well as the potential downgrade of more than 100 banks by Moodys Investors Service have us once again adding Europe to that list of clouds on the horizon.

One of the near-term questions is whether or not Greece will leave the euro, as well as how will Athens find the savings for 2013 and 2014 in order to receive the $169 billion bailout from the European Union and International Monetary Fund. In France, socialist Francois Hollande defeated center-right President Nicolas Sarkozy and pledged to push for less austerity and more growth in the region, what turns out to include prospects for higher taxes, particularly on the wealthy.

Amid the current economic contraction in Europe, with both Britain and Spain now in a double-dip recession, it seems the storm will persist in the coming weeks and months. The ripple effect of that storm will have repercussions on our domestic economy and stock markets in the coming weeks.

As always, I look for context in order to assess the situation and normally that means lining up a number of data points. In this case, the context is where we are in the overall stock market — in early April, the S&P 500 reached a near-term peak of 1,419, its highest level since May 2008.

In the past several weeks, however, it has pulled back close to 4 percent but is still up 8.5 percent for the year. Given the direction of recent economic data and the rise in uncertainty, it seems we are setting the stage for a continued move that at best can be described as sideways, but more likely to be down than up. Reinforcing that view, earnings per share for the S&P 500 group of companies is slated to rise only rise 4.7 percent year-over-year in 2012 compared to 14.7 percent in 2011 and more than 40 percent in 2010, according to the most recent data from Thomson One. Generally speaking, as earnings growth slows, P/E multiplies and other valuation metrics have compressed, not expanded.

After the slow data flow this past week, next week will see a number of key economic reports for April, and the second round of corporate earnings reports kicks off with an emphasis on retailers.

While those companies — Limited Brands Inc., Aeropostale Inc. and Wal-Mart Stores Inc. among others — will offer some insight to the attitudes of consumers, who started taking on debt once again in March following two months of declines, I'll be listening to see if falling commodity prices translate into profit enhancers in the back half of 2012. Also, Facebook is also expected to price its initial public offering next week and I suspect that will attract a lot of attention, not just for the offering price but also for the related valuation.

My advice: Keep building that shopping list of great companies that you would want to buy. As carpenters know, it's measure twice, cut once. The same advice applies to investing in stocks.

Chris Versace is editor of the PowerTrend Brief and PowerTrend Profits newsletters. Visit them at ChrisVersace.com, or follow him on Twitter @_chrisversace. At the time of publication, Mr. Versace had no positions in companies mentioned; however, positions can change.