1980s Valuations for Stocks – Weekly Market Outlook

Isn’t it amazing how stocks can stop and turn on a dime? From a 6.1% bearish swing in six trading days to a bullish swing of 5.4% over the past five trading days. It’s just amazing, and a testament to how undecided traders are right now. And, it’s also a warning to not dig in too deep just yet on either side of the market – we’re still feeling the aftershocks of the early-August 17% meltdown.

We’ll examine where this zig-zag pattern is apt to take us next, right after a closer look at some key economic numbers.

Economic Calendar

Not only was it a wildly bullish week for stocks last week, it was wildly bullish despite some troubling economic numbers…. of which there were plenty. Here are the highlights (or lowlights, as the case may be).

* Inflation – The good news is, producer inflation was reined in last month, glowing little to none. Yet, the annualized PPI rate is still 6.5%. The consumer price inflation rate now stands at an annualized 3.77% – the highest since late 2008 – after advancing 0.4% in August. Both are starting to take a toll.

* Retail sales – One of the few bright spots of the recovery process so far, retail spending growth really slowed up (to nothing) last month, with or without cars. It’s not an alarm just yet, but be wary of another no-growth month.

* Industrial Production/Capacity Utilization – Fortunately for the bulls, these two indicators continued to show growth in August, even if it was tepid growth. Productivity was up 0.2%, and capacity usage rose from 77.3% to 77.4%, which is actually quite a bit for numbers like these. [These are both key data points as both have shown an amazing degree of correlation with long-term bull and bear markets.]

Economic Calendar

As for the coming week, it’s much lighter in terms of data quantity, but we’re getting a lot of big numbers on the real estate front (with more real estate data to come next week).

* On Tuesday look for housing starts and building permits to both fall back from July’s levels, though some of that can be attributed to seasonal factors. Both have been stagnant since early 2009, though neither has actually worsened (despite suggesting that they have).

* Wednesday’s existing home sales figure should edge slighting higher, to an annual rate of 4.7 million.

* On Thursday we’ll get the usual unemployment claims figures; both should be basically in line with the prior week’s levels. Bluntly though, the numbers themselves have become a little meaningless, and the market’s response to them has become a coin toss.

Stock Market

The good news is, the S&P 500 (SPX) (SPY) not only rallied nicely last week, it did so on higher volume (and not just because volume was being compared to the prior four-day week). The bad news is, the S&P 500 didn’t actually clear any major hurdles.

As the chart indicates, there’s a big ceiling around 1233, where the upper Bollinger band (20-day) AND the 50-day moving average line AND the prior peak (from August 31st) are all lining up. While Friday’s close of 1216 puts the SPX within striking distance of that resistance zone, getting above it is going to be a different story. In fact, given the hot/cold environment we’re still in, it’s not likely the index will get over that hump.

In tune with – and in support of – that idea is the CBOE Volatility Index (VIX) (VXX) (VXZ), which is not yet back to its lower Bollinger band, but is back at its recent floor around 31.0 (the lower band line is at 29.0).

SPX & VIX Daily Chart

Now, with the VIX still two points away from a major support area and the S&P 500 still 17 points below its key resistance level, there’s still room for more bullishness. Don’t be fooled though…. until both indices actually work their way past their respective walls, it’s not as if any great feat has been accomplished. As such, it’s not as if there’s a bulletproof reason to be bullish.

On the flipside, in the very unlikely case that the index does punch through its ceiling and the VIX pushes under its floor, there’s at least a smidgen of a chance for trade-worthy bullishness. [The problem even then is a couple of more key moving averages above 1233 that could hold the market down.]

The downside target is still 1124, where the SPX’s lower Bollinger Band as well as prior key lows are currently intercepted.

As always, the weekly chart of the S&P 500 can offer a little bit of additional perspective….. which it does this week in particular.

S&P 500 – Weekly

While the weekly version of this chart doesn’t suggest bullishness is unfurling any more than the daily chart does, with the weekly chart we can really start to see just how extreme the bearish move was, and just how well/quickly the bulls at least stopped the bleeding. There is far more upside (rebound) potential than downside potential packed into this chart – the key is just unleashing it. The stifling wound from August’s implosion is one that only a decent amount of time can heal though, which likely pushes back any ‘unleashing’ for a few more weeks.

In some ways, however, putting any rebound on hold until Q4 gets rolling may be the best thing for the bulls.

It’s better to start a rally that can be sustained than start one that may have the rug pulled out from underneath it. By October, confidence may be restored enough to keep investors in a buying mood even through a little bad news. And, the needed psychological victories to restore that confidence are already being set up. Standard & Poor’s has actually lowered Q3’s overall earnings expectations for the S&P 500 despite Q2’s near-record earnings levels, and Q3’s continued (albeit modest) economic strength. In other words, the bar for third quarter’s earnings is set pretty low.

How low? As of the last look, Standard & Poor’s is looking for the S&P 500 in Q3 to earn $24.36 on an operating basis, and $23.42 on a GAAP/reported basis…. about a 13% YOY improvement instead of the original 17% YOY improvement the organization was looking for a few weeks ago. Folks, THAT’S STILL A RECORD ON BOTH FRONTS, and puts the S&P 500’s trailing-twelve-month P/E at 12.9… the lowest it’s been since the late 80’s.

Like we said, third quarter’s low-hanging fruit leaves the door wide open to a lot of earnings beats and excitement over low valuations.

S&P 500, with Earnings & P/E Ratio

Trade Well,

Price Headley