Trading Range or Stock Correction Remain Most Plausible Scenarios

April 15, 2014
 
  1. The mixed-bag economy and mixed-bag market continue to call for defensive contingency plans.
  2. Given what we know today, a rapid and sustainable push to new highs in stocks appears to be the least likely scenario, behind consolidation/correction.
  3. Earnings have been decent so far, but Wall Street makes sure the expectation bar is set at a comfortable level.
  4. An allocation of stocks, bonds, and cash allows for needed flexibility and migration paths until a more dominant theme can emerge.

Playing The Low Estimate Game

Isn’t amazing how the majority of companies meet or beat earnings expectations quarter after quarter? Wall Street has always done a nice job of managing investor expectations. From Bloomberg:

“It’s quite likely that U.S. earnings will beat expectations because analysts have set the bar quite low,” James Butterfill, who helps oversee about $50 billion as head of global equity strategy at Coutts & Co., said by phone from London. “There probably won’t be any particular pressure on margins this quarter, so earnings momentum will continue to rise. I do expect the harsh winter to have impacted the most energy-intensive companies.”

Inflation Aligns With Ongoing Fed Taper

The good news Tuesday came on the earnings front, with Coca-Cola (KO) and Johnson & Johnson (JNJ) eliciting a bullish response. The bad news was related to inflation. From Reuters:

U.S. consumer prices rose in March, but inflation pressures remained generally benign, which should give the Federal Reserve ample scope to keep interest rates low. The Labor Department said on Tuesday its Consumer Price Index increased 0.2 percent last month as a rise in food and shelter costs offset a decline in gasoline prices. Economists polled by Reuters had expected a 0.1 percent rise.

Central bankers tend to print money until inflation forces them to slow down the presses. Today’s inflation data aligns with an ongoing Fed taper.

Ukrainian Military Action?

The unrest continues between Russia and Ukraine. It is possible the markets will have to digest some form of military action, which checks a glass half empty box. From The Wall Street Journal:

A Ukrainian military operation to wrest control of cities in the east from pro-Russian militants has begun, Ukraine’s acting president said Tuesday, as Russia’s foreign minister warned use of force could derail international talks on the crisis. Oleksandr Turchynov said that a phased “antiterrorist” operation began in the early morning hours in the northern Donetsk region, where the majority of the cities commandeered by pro-Russian forces are located. But there were no immediate reports of specific action and it was not clear how big the effort was.

Investment Implications: Mixed Bag = Mixed Allocation

From a fundamental perspective, there are many positives (earnings Tuesday) and many negatives (Fed taper). From a technical perspective, the longer-term trends remain bullish, but the intermediate-term trends shifted to a “risk-off” stance last week. Our nearly equal weights to cash, stocks (SPY), and bonds (TLT) remain appropriate for the current mixed investment climate.

Resistance Test Would Come At 1,850

Another example of a mixed picture is the chart of the S&P 500 below. The good news is the index has gained back 25 of the 49 points lost last week (early in Tuesday’s session). The bad news is various forms of prior support (green arrows below) and prior resistance (red arrows) seem to be congregating near 1,850ish. A reversal below 1,850 could bring a return to last week’s risk-off environment. A decisive break above 1,850 could open the door to a retest of the recent highs (near 1,900).

We have shown frustrating and indecisive charts in recent articles. We could produce additional examples from numerous corners of the market, including the chart of the small cap ETF (IWM) below. If investors had strong convictions about a brighter economic future, we would expect small caps to be performing well, rather than treading water for six months.

Indecisive markets are frustrating animals. If we remain patient and disciplined, the market will tip its hand. For now, a mix of stocks, bonds, and cash offers an appropriate balance between risk and reward. We questioned the sustainability of the bullish advance in stocks on April 4 with the S&P trading at 1,865. We remain concerned with the S&P trading at 1,827.

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