A Look at the Current Macro Environment
Thursday, November 8, 2012
Charles Rotblut, CFA
AAII Journal Editor

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Sentiment Survey

This week’s AAII Sentiment Survey results:
  Bullish: 38.5%, up 2.8 points
  Neutral: 21.6%, down 1.7 points
  Bearish: 39.9%, down 1.1 points

Long-term averages:
  Bullish: 39%
  Neutral: 31%
  Bearish: 30%

Take the AAII Sentiment Survey »

When investing, it is always good to step back, take a deep breath and assess the current macro environment.

I’ll start off with the election, mainly because I feel that saying nothing about it would be to ignore the proverbial elephant in the room. The U.S. will have a divided government for at least two more years and politicians on both sides of the aisle are going to have to learn how to play nice in the sandbox. From an economic standpoint, avoiding the forthcoming fiscal cliff is the biggest short-term issue. But, a bipartisan agreement on debt reduction, taxes and spending could also go a long a way toward giving the markets confidence and potentially spurring stronger economic growth.

I’m not going to speculate on how this will play out. I do expect many investment newsletters and services to play off the fears of a worst-case scenario. My advice is to ignore them. When the facts are unclear—as they are now—following a strategy based on what Washington might or might not do can cause more harm to your portfolio than if you simply stayed diversified and looked long term.

There is also already chatter about which sectors and industries will do well or suffer as a result of the president’s re-election. Health care reform will continue to be rolled out. Growth in defense spending could slow, though members of both parties have a long history of trying to protect programs that benefit their constituents and campaign donors. President Obama won’t be friendly to the coal industry, which hurts railroads in turn, but global economic growth and the trend in natural gas prices are wildcards. Alternative energy should benefit, but this has been a risky sector to invest in. The Dodd-Frank Wall Street Reform Act will not be repealed, and its continuing implementation should be considered when looking at financial stocks. Keep in mind, however, that if the president wants to get legislation passed, he will have to make compromises on what gets done and carefully choose where to spend his political capital.

Shifting to third-quarter earnings, profits have been exceeding expectations, but sales have not. As of this morning, Thomson Reuters I/B/E/S says 63.4% of the 440 S&P 500 companies that have reported earnings so far beat their consensus estimates, while 26.4% have missed. This compares to the historical beat rate of 62% and miss rate of 21%. Conversely, 37.6% of reported S&P 500 companies have topped revenue expectations, while 62.4% have missed. In a typical quarter, 62% of companies top revenue forecasts and 38% miss.

Earnings are on pace to have declined by 0.2% in the third-quarter. This is better than the 2.1% decline analysts had feared at the start of October, but well below the 3.0% growth they had hoped for at the start of July. Revenues are on pace to decline 0.7%, which is worse than both the October 1 forecast for 0.1% growth and the July 1 forecast for 1.9% growth.

As you might suspect, analysts have been less upbeat about earnings. Though our earnings estimate revisions screens are good for finding potential buy and sell candidates, they also can provide insight on what analysts are doing. (I used our Stock Investor Pro program to look at these screens, which is updated more frequently than the screen results published on our website.) Currently, just 25 companies are passing our Earnings Estimates Revised Up 5% screen. (Whirlpool (WHR) is the only S&P 500 member passing the screen.) Conversely, 83 companies pass our Earnings Estimates Revised Down 5% screen. (Best Buy (BBY) and DuPont (DD) are among the 12 S&P 500 members identified by the screen.)

The declining revenues and earnings estimate cuts are not surprising given the slow pace of economic growth and macro headwinds. It is also possible that some businesses have curtailed spending ahead of the fiscal cliff. It is certainly hard to plan for projects if you don’t know what your tax rates will be.

Valuations for stocks remain fairly attractive. S&P Capital IQ calculates a price-earnings ratio of 14.15 for the S&P 500. This equates to an earnings yield of 7.1%. In contrast, the benchmark 10-year Treasury note yields 1.63% and the 30-year bond yields 2.75%. The numbers are impacted by current Federal Reserve policy and valuations can stay out of whack for an extended period of time, but they do favor owning stocks.

Finally, a quick comment about the market’s price trend. The S&P 500 tested its 200-day moving average today, after breaking below its 50-day moving average a few weeks ago. The trend is not positive, but I’m not surprised or overly concerned. The markets have had a good run this year, third-quarter earnings were not great, the deadline for avoiding the fiscal cliff is nearing and Europe’s debt crisis has yet to be resolved. So, some weakness was likely to occur.

We’re ultimately in the same situation we’ve been in throughout the year; things could either go right or wrong. Uncertainty does bring opportunity, however, and you won’t see the “all clear” sign until stocks have rallied significantly higher.

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The Week Ahead

The bond market and the banks will be closed on Monday, in observance of Veteran’s Day. The stock market will operate normal trading hours. Thank you to all of you who served in our military.

I will be speaking to our Pittsburgh chapter on Tuesday, November 13, and to our Cleveland chapter on Wednesday, November 14. More information about all of our local chapters can be found on AAII.com.

Approximately 20 members of the S&P 500 are scheduled to report earnings next week. Included in this group are Dow components Cisco Systems (CSCO) and The Home Depot (HD), which will report on Tuesday, and Wal-Mart (WMT), which will report on Thursday.

We’ll see the first economic reports of note on Wednesday, when the October Producer Price Index (PPI), October retail sales, September business inventories and the minutes from the October Federal Open Market Committee meeting are published. Thursday will feature the October Consumer Price Index (CPI), the November Empire State Manufacturing Survey and the November Philadelphia Federal Reserve manufacturing survey. October industrial production and capacity utilization will be published on Friday.

Several Federal Reserve officials will speak publicly next week: San Francisco President John Williams on Wednesday; Richmond President Jeffrey Lacker, Dallas President Richard Fisher and Philadelphia President Charles Plosser on Thursday; and Atlanta President Dennis Lockhart on Friday.

November stock options will expire on Friday.

AAII Sentiment Survey

Bullish sentiment rose to its highest level since August, while bearish sentiment remained above its historical average in the latest AAII Sentiment Survey.

Bullish sentiment, expectations that stock prices will rise over the next six months, rose 2.8 percentage points to 38.5%. Optimism was last higher on August 23, 2012. The rise puts bullish sentiment close to its historical average of 39%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, declined 1.7 percentage points to 21.6%. The last time neutral sentiment was lower was October 6, 2011. The historical average is 31%.

Bearish sentiment, expectations that stock prices will fall over the next six months, declined 1.1 percentage points to 39.9%. This is the first time in four weeks that pessimism is below 40%, though the current reading is admittedly just barely below that mark. This is also the 11th consecutive week and the 27th out of the last 31 weeks that bearish sentiment has been above its historical average of 30%.

Bullish sentiment came in above 38% for the just the second time since April 5, 2012, a sign of just how much this year's rally has been mistrusted. Bullish sentiment has been below its historical average of 39% during 31 of the past 32 weeks. Whether this week's numbers mark a turning point or just a temporary blip remains to be seen. It is worth noting, however, that it is not just our survey that has shown an improvement in individual investor sentiment. Data published by the Investment Company Institute shows that the amount of weekly estimated outflows from domestic equity mutual funds has decreased during four out of the past five weeks.

Due to the survey's period of Thursday through Wednesday, the impact of the election's results are only partially reflected in the survey's results. Many individual investors are also cautiously watching Washington to see what will be done about avoiding the fiscal cliff, reducing the debt and aiding stronger economic growth.

This week’s special question asked AAII members how much the European sovereign debt crisis is influencing their six-month outlook for stocks, especially relative to six months ago. Responses varied, though about half of the respondents said Europe’s debt crisis was not having much of an impact or that their sentiment has not changed because of the crisis. About a third of the respondents said they have a negative outlook or their sentiment has worsened because of the crisis. A smaller group said the crisis has not changed their outlook.

Here is a sampling of the responses:

  • “Not a lot. I’m more concerned with our do nothing Congress and the fiscal cliff.”
  • “Less than six months ago. I think we are suffering from impending-crisis-fatigue.”
  • “A lot less. I don’t know why, because the problem has not gone away, but the anxiety about the situation is gone.”
  • “I’m not sure that the European Union has the problem solved and wrapped up in a bow, but it’s out of the headlines as the fiscal cliff is the worry du jour.”
  • “It’s having a greater influence because the actions thus far have just put off an inevitable disaster.”
  • “It does cause me to have a concern about how this is going to affect our own markets in the future.”

» Take the sentiment survey