I really wish I could have faith in last week’s rally.
I’d love to sound the all-clear, and return to the halcyon days of a rising tide lifting all stocks.
Unfortunately, we ain’t done yet.
The only silver lining we can appreciate is that the market is closer to where it should be, and that anything we buy today is significantly less expensive than it was at the end of last year.
Let’s take a look at some of the best indicators out there to get a feel for where we are now, and use that data to figure out what we should do now.
The Big Picture
The last time the S&P 500 topped 2100, the level it roughly traded around for a lot of last year, was on December 1, 2015. Going into trading recently, it was sitting at 1917.
Since then, we’re looking at about a 7.8% drop going into today. To climb back up, we’d need to see a 9.5% rally.
We have a long way to go to get back to that level, and some strong resistance levels to cross, too.
The drop has deflated the market some, and I hate to say it, but it probably hasn’t been as much as you’d think.
Arguably the best big picture tool we have to judge the markets is the Shiller cyclically adjusted price-to-earnings ratio. The market drop helped, but it hasn’t dented it as much as we should hope, nor does it support anything like the multi-year rally we have behind us:
The mean is 16.65, and the median is 16.02, so we’re still sitting pretty high compared to historical data.
CAPE is about as macro as you can get, though, so let’s look at a better forward indicator, one that you’ll know I’m quite enamored with, if you’re familiar with my past analysis.
Follow the Money
We can dig into data until our eyes start bleeding, but nothing is quite as good as simply looking at how well companies are making money.
That isn’t looking all that hot either, judging by the information put out by FactSet at the end of last week.
First up, let’s check out what the drop has done to bring share prices back in line with earnings:
Yeah, it helped, but we’re still seeing a wide mismatch. The data isn’t pretty either.
87% of companies on the S&P 500 have reported earnings, with 68% beating mean earnings estimates, and 48% reporting sales above the mean estimate.
Earnings are fairly easy to game a bit, with buybacks being the most popular trick by far. However, you can’t mask bad sales figures.
Companies will always see share prices drop when sales and revenues stagnate or shrink. If they can’t make more money than they did before, it isn’t worth paying the equivalent of a couple decades of earnings for shares.
It truly is as simple as that.
Fourth quarter had some pretty big downgrades over the last several months. Blended earnings saw a 3.6% decline, marking the first time we’ve seen that in three consecutive quarters since Q1 through Q3 2009.
The data also shows that companies with greater foreign exposure suffered more than companies with greater domestic exposure.
So far, Q1 2015 isn’t looking too pretty either. A total of 97 companies — about a fifth of the index — have revised estimates. 78 issued negative EPS guidance, and 19 revised upwards.
It is a bit early to say for sure, but we’re looking at the very strong probability of a fourth quarter of earnings and sales declines.
Q4 2015 saw revenues decline 3.7% overall, and revenue is flat or shrinking, depending on how optimistic the analyst is, for Q1 and Q2 of this year.
So yeah, the short version is, we ain’t done yet and it ain’t looking any better now than it did two months ago when the markets realized that everything isn’t awesome anymore.
Toughing Through It
There are a handful of things we can do to keep an eye on the situation, considering we have about five months and two quarters of economic and fiscal reports before we can realistically get optimistic about the broader market.
Remember how companies with foreign exposure did worse? That’s because international economies are looking pretty bad.
Keep an eye on them, especially for widening gulfs between economic estimates and results on the downside. If we see more of it, we know that those companies will be on the bad end of earnings and revenue results yet again.
Plus, when that happens, people are reminded that central bankers and macro economists are pretty much just guessing anyway, and that will amplify fear and volatility even more.
Another thing to watch will be the new negative interest rate policies. I’m not even going to get into how absolutely absurd and destabilizing these will be if they persist for any significant length of time, but watch out.
This kind of behavior is basically endgame, Hail Mary-style desperation. Punitive measures for not flooding equities with all the capital available can only backfire because, no matter how optimistic investors often want to be, it is completely transparent.
As for what we can do now? Well, thankfully the market is broad and deep, and we always have options.
Keep it domestic, keep your large cap investments producing income, and focus on sectors and trends that support growing revenues.
As for us here at the Outsider Club, we’ve been researching our options all day, and letting the discussion spill over into happy hours.
The consensus we’ve reached involves a two-prong strategy:
Allocate a large portion of new funds dedicated to core portfolios to the best dividend stocks — ones that have increased payouts every year for at least half a century — while using techniques to eliminate fees.
Focus on small stocks that are poised to capitalize on the initial revenue growth surge of new domestic markets.
