Short-Term Consolidation Likely
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Paul Rabbitt
Rabbitt Analytics.com |
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Our stock purchase candidate lists have been severely curtailed by the summer rally, which has driven issues sharply higher. Upward moves from here are becoming increasingly speculative. We have warned against "performance chasing". We would not aggressively add to positions. This is time to move into a holding mode.
The second quarter earnings season will close in the next ten days. The absence of earnings news may become a signal for profit-taking prone investors to become more aggressive. Our increasingly short-term cautious stance should be taken in context of our bullish view for the remainder of the year. Any pullbacks will be healthy and create additional purchase opportunities.
As Earnings News Fades, Focus Will Shift to Economic News
According to earnings aggregator First Call, nearly three quarters of the companies in the Standard & Poor's 500 have reported and three quarters of those have beaten their consensus street estimates, the highest since the first quarter of 2004. A month ago, the estimate called for 7.5 percent growth. Now the result should be closer to 10.5 percent. The earnings expansion proves earnings can push higher despite the Fed's nine consecutive rates hike in a year.
The economy is strong. Second quarter GDP grew 3.4 percent for its ninth straight quarter of above three percent growth. Moreover, inventories fell as auto dealers cleared their lots and manufacturers delayed ramping up new manufacturing, thus assuring increased activity in the future. The Chicago Purchasing Management Index posted a sharp jump in July. In July, U.S. non-farm payroll numbers were strong with some evidence of rising wage pressure. We see no reason the Fed might cease its policy of steady rate hikes.
High Expectations Equal Danger
Expectations have risen with stock prices. High expectations are often too lofty, resulting in disappointments. Of course, if crude prices rise above $60, an old short-term reason for disappointment will be available. Probably even more significant, the recent bond sell off and commensurate rise in interest rates may be a stronger signal that risks are raising. The bell-weather ten-year bond yield jumped to 4.27 percent last week. Bond rates have raised more than 30 basis points in July.
The summer rally continued with the biggest monthly gain this year in July as stocks gained a solid 3 percent. Small-caps led the way with gains of 6 percent. Growth stocks combined with growth stocks and the energy sector to also pull stocks higher. Defensive issues, which still have the highest returns year-to-date, also rose but they lagged the more aggressive growth issues in July.
All-in all, this has been a good market. Despite short-term pressures to consolidate, the year should close on an up-note. | 
