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Note: The earlier Market Analysis email had a wrong Roundtable Review link. It has been corrected below.
The market seems to have hit the skids lately, with stocks down roughly 3.5% from the recent early April highs. This is making many investors nervous, as is evident from the sharp jump in the CBOE's VIX Index, generally considered a good proxy for market anxieties.
The recent run of mixed U.S. economic data, along with a less than clear picture on the labor market following the surprise miss in March and the subsequent jump in weekly jobless claims, has emerged as a material negative driver for the market. Few expect the ongoing earnings season to bring the market's mojo back. Growth numbers out of China have not been particularly bad they certainly don't fit the 'hard landing' narrative but they haven't inspired much confidence either. Most importantly, the re-emergence of Europe-centric fears, this time focused on Spain, has reminded investors that this issue has hardly gone away.
Is it the end of the market's impressive run from the late-November 2011 lows through the start of this month with gains exceeding 18%? Or is it just a temporary slide during which the market may give back a couple more percentage points? I am more inclined towards the latter alternative as I continue to believe that the overall forces that gave us the bull run is still in place.
In today's piece, I give the reasons why I think so. We discussed this same issue in today's Roundtable Review.
Soft Data May Not Be So Bad
The quip that 'the market is addicted to QE' may not entirely be off base. Ever since the Fed initiated its last quantitative easing (QE) program in the fall of 2010, investors have constantly been clamoring for more from the central bank. Along the way, market participants would evaluate most economic reports from the perspective of its impact on the odds of more QE. Weak economic reports meant increased likelihood of Fed support and vice versa.
Improved economic readings over the last four to six months, particularly on the labor market front, were generally believed to be QE unfriendly. Minutes from the Fed's March meeting, released just days before the March jobs report, poured further cold water on additional QE hopes. But all that has changed following the jobs miss and the subsequent increase in weekly jobless claims. Even the Fed officials have lately been describing the economy as 'not out of the woods yet', which is believed to mean that the economy may need more support from the central bank.
I don't believe that the March jobs miss is a sign of things to come. The strong job numbers over the winter months were a function of favorable weather and the numbers going forward will reflect the much weaker ground realities. There is plenty of corroborating evidence suggesting that the economy has enough momentum to generate labor market gains resembling the last few months. That said, in the unlikely event of the economy losing momentum, we have enough indication from the Fed that it will come through with more support.
I would prefer the market get over the need for more QE. But in the current situation, stocks stand to benefit from either scenario.
Europe Is Not an Existential Threat
China appears to be doing fine; meaning that its economy is slowing down, but the slowdown is far less sinister than the hard landing situations many have been predicting. The country's first quarter GDP growth rate of 8.1% missed the expected and whispered numbers, but is nothing to lose sleep over. Importantly, the composition of growth has a number of favorable aspects, including less reliance on investments in fixed assets and more growth in consumer spending. Bottom line, while questions about Chinese growth will remain a key concern for the market, the country does not appear to be heading towards material slowdown.
More than China, it's the re-emergence of Europe related fears that seems more problematic. Yields on Spanish government bonds have been inching up in recent days and have now reached their highest level since December 2011, when the European Central Bank's (ECB) liquidity operation turned the sentiment around on the currency union's fortunes. The ECB has since completed another round of liquidity operations.
The recent upturn in Spanish yields and the return of anxieties reflects the country's weak economic growth prospects, doubts about its ability to meet even the revised deficit targets, and less than clear communication from its relatively new government on the budget issue. The weak financial state of the country's banks adds to these problems. The chart below from the Economist.com shows this negative turn of events:
Spain is a big economy, much bigger than Ireland, Portugal and Greece that have received bailouts thus far. But the situation may not be that hopeless either. The ECB may not be able to do another liquidity operation so soon after its February second round, but it could support the government bond market directly in secondary market purchases. That said, headlines about Spain are expected to remain the major negative cloud for this market in the coming days.
Putting It All Together
The broad set of forces that gave us the stock market run up from the late November lows through the beginning of this month have weakened a bit, but are still largely in place. While I don't envision the market retracing its steps, some additional weakness over the coming days may not be inconsistent with an overall constructive outlook for the market. It is perhaps reasonable to expect greater volatility in the spring/summer months compared to what we encountered in the first quarter, largely due to Spain-related headlines, though the situation in that country is potentially a lot less troubling than was the case with Greece.
We did not make any changes to the Focus List this week.
My explanation for keeping MarkWest Energy Partners (MWE - Analyst Report) in the portfolio remains in place as the stock still has a Zacks #4 Rank. As I explained last week, we are making an exception in MWE's case, but would otherwise have removed it from the portfolio.
As this week's return of Europe-related headlines show, our strategy of having an outsized focus and exposure to the domestic market is a prudent course of action. The U.S. economy provides decent and stable growth prospects compared to many other regions of the world. Some of the best performing stocks on the Focus List outside of Apple (AAPL - Analyst Report) have been such U.S. centric businesses. These include restaurant operator Chipotle Mexican Grill (CMG - Analyst Report), rural retailer Tractor Supply Corp. (TSCO - Analyst Report), railroad operator Kansas City Southern (KSU - Analyst Report), and industrial distributor Fastenal (FAST - Analyst Report), just to name a few. We will stick with this theme for as long as the global economic outlook does not materially change.