Click here for the Weekly Wrap by Briefing.com.
BOTTOM LINE: Overall, last week's market performance neutral, considering last week’s sharp gains. The advance/decline line fell, sector performance was mixed and volume was light on the week. Measures of investor anxiety were mixed. The AAII % Bulls rose to 39.35% this week from 30.53% the prior week. This reading is now at below-average levels. The AAII % Bears rose to 37.42% from 35.79% the prior week. This reading is still at above-average levels. Moreover, the 10-week moving average of the % Bears is 44.36%. It has been this high during only one other period since record-keeping began in 1987, the significant market bottom during the 1990 recession and Gulf War. It never even reached current levels during one of the greatest stock market collapses in U.S. history from 2000-2003. Many other measures of investor sentiment are still near levels normally associated with meaningful market bottoms. It is quite likely that investor sentiment towards US stocks has never been this poor in history given the positive macro backdrop.
The average 30-year mortgage rate fell 4 basis points to 6.48%, which is 32 basis points below July highs. I still believe housing is in the process of slowing to more healthy sustainable levels. Mortgage rates have likely begun an intermediate-term move lower, which should help stabilize housing over the next few months. The Case-Shiller housing futures are projecting a 5.0% decline in the average home price over the next 9 months. Considering the average house has appreciated over 50% during the last few years, this would be considered a “soft landing.”
The benchmark 10-year T-note yield fell 6 basis points on the week on weaker housing data and diminishing inflation worries. I still believe inflation concerns have peaked for the year as economic growth moderates to around average levels, unit labor costs remain subdued and the mania for commodities continues to reverse course.
The EIA reported this week that gasoline supplies rose more than expectations as refinery utilization increased. Unleaded Gasoline futures fell and are now 34.5% below September 2005 highs even as refinery utilization remains below normal as a result of the hurricanes last year, some Gulf of Mexico oil production remains shut-in and fears over future production disruptions persist. According to TradeSports.com, the percent chance of a US and/or Israeli strike on Iran this year has fallen to 13.5% from 36% late last year. The elevated level of gas prices related to crude oil production disruption speculation is further dampening fuel demand, which is beginning to send gas prices back to reasonable levels.
US oil inventories are near 7-year highs. Since December 2003, global oil demand is only up .1%, while global supplies have increased 5.3%. Moreover, worldwide inventories are poised to begin increasing at an accelerated rate over the next year. I continue to believe oil is priced at extremely elevated levels on fear and record speculation by investment funds, not fundamentals. Escalating tensions with Iran and a Gulf hurricane will likely lead to a major top in oil over the next 6 weeks as demand destruction further accelerates. As the fear premium in oil dissipates back to more reasonable levels, global growth slows and supplies continue to rise, crude oil should head meaningfully lower over the intermediate-term.
Natural gas inventories rose more than expectations this week. Supplies are now 13.5% above the 5-year average, a high level for this time of year, even as some daily Gulf of Mexico production remains shut-in. Natural gas prices have plunged 54.7% since December 2005 highs. Colorado State recently reduced its forecast from five to three major hurricanes for this season versus seven last year. I expect natural gas to make new cycle lows in December or January.
Gold fell on US dollar strength and diminishing inflation fears. The US dollar rose on short-covering and weaker economic data from Europe and Asia. I continue to believe the Fed is done hiking rates for this cycle.
Energy stocks outperformed for the week on short-covering and hurricane disruption speculation. The Retail sector underperformed substantially as investors continue to price in a collapse in consumer spending. I expect Retail to outperform during the fourth quarter as these fears prove unfounded. S&P 500 profit growth for the second quarter is coming in a strong 13.2% versus a long-term historical average of 7%, according to Reuters. This would mark the 16th straight quarter of double-digit profit growth, the best streak since recording keeping began in 1936. Moreover, another double-digit gain is likely in the third quarter. Despite a 74.5% total return for the S&P 500 since the October 2002 bottom, its forward p/e has contracted relentlessly and now stands at a very reasonable 14.9. The 20-year average p/e for the S&P 500 is 24.4. The S&P 500 is up 5.0% and the Russell 2000 Index is up 4.6% year-to-date, notwithstanding the recent correction.
The current pullback is still providing longer-term investors very attractive opportunities in many stocks that have been punished indiscriminately. In my entire investment career, I have never seen the best “growth” companies in the world priced as cheaply as they are now relative to the broad market. By contrast, “value” stocks are quite expensive in many cases. Moreover, the most overvalued economically sensitive and emerging market stocks should continue to underperform over the intermediate-term as the manias for those shares subside. I still believe a chain reaction of events has begun that will eventually result in a substantial increase in demand for US stocks.
In my opinion, the market is still factoring in way too much bad news at current levels. One of the characteristics of the current “negativity bubble” is that most potential positives are undermined or downplayed, while almost every potential negative is exaggerated and promptly priced in to stock prices. Problematic inflation, substantially higher long-term rates, a significant US dollar decline, a “hard-landing” in housing, a plunge in consumer spending and ever higher oil prices appear to be mostly factored into stock prices at this point. I view any one of these as unlikely and the occurrence of all as highly unlikely.
Over the coming months, an end to the Fed rate hikes, lower commodity prices, decelerating inflation readings, lower long-term rates, increased consumer confidence, rising demand for US stocks and the realization that economic growth is only slowing to around average levels should provide the catalysts for another substantial push higher in the major averages through year-end as p/e multiples begin to expand. I still believe the S&P 500 will return a total of around 15% for the year. The ECRI Weekly Leading Index was unchanged this week and is forecasting healthy, but decelerating, US economic activity.
*5-day % Change