Stocks continue to trade in a sideways technical consolidation just below their highs. With the start of earnings season underway, investors appear to be looking for a catalyst for some renewed buying that can launch a bullish breakout. The big banks reported some pretty good numbers last week, and now all eyes are watching Technology, Industrial, and Consumer companies, not just for Q4 results but primarily for forward guidance. For 2014, the name of the game will be top-line growth, not just cost-cutting and productivity gains.
So far, corporate earnings reports have been nothing spectacular, but there have been no notable disasters, either. Among the ten U.S. business sectors, the performance leader so far in the new year has been Healthcare, followed by Technology and Financial. I view this sector leadership as bullish. Also, given the record call option open interest on CBOE Market Volatility Index (VIX) futures, traders appear to be positioning for an overdue market correction. So, the contrarian view is that another test of support around 12 for the VIX could finally produce a breakdown, launching a round of short-covering that could add fuel to the bulls’ fire.
Most of the macro risks that paralyzed corporate investments in 2013 have greatly diminished. Congressional gridlock has eased, and we now have a markedly lower deficit and a strong likelihood of elevated tax revenues. The U.S. budget surplus hit $53 billion last month, and for the first three months of the current fiscal year, the deficit is only $174 billion, which is $120 billion less than last fiscal year’s first three months. Among other positive signs for improvements in the economy and corporate earnings, capital spending and job growth are both rising, and lending volumes are now well above the 2007 peak, before the financial meltdown. General Motors (GM) announced a resumption of its dividend payments, after a 5-year hiatus for its government bailout and restructuring, reflecting a 3.1% yield.
So long as the rates stay range bound, e.g., a 10-year Treasury bond yield between 2.5-3.5%, the experts seem to agree that equities will remain the primary beneficiary of capital flows. P/E multiples and earnings yield in U.S. stocks are not out of line in comparison. So far in 2014, the 10-year has fallen back down to 2.82%. So, although the future direction of longer-term yields is up, evidently it won’t be coming fast and furious, perhaps due to investor caution about equity valuations (however misplaced). To me, it all points to additional upside in equities in the coming months, with just enough of a “wall of worry†to prevent another episode of “irrational exuberance.†Instead, it should help the best growth companies with the most favorable valuations and solid earnings quality to attract capital (“flight to qualityâ€) and serve as the market leaders.
