Three signs the U.S. equity market has peaked

Oct 30, 2012

 

Reuters/Shannon Stapleton
We see more downside risk than upside potential in the coming months. 
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The S&P 500 has been surprisingly resilient in the midst of the global economic slowdown, particularly because investors have been flocking to U.S. equities as the perceived safer macro trade and underweight fund managers have been buying the dips.

However, the $64,000 question among pundits and investment professionals alike is just how much room for growth is left from current levels? The lack of optimism appears to be reflected in recent trading activity, with the S&P 500 being flat and range-bound between 1,430 and 1,470 since the QE3 announcement on Sept. 13. Not surprisingly, the old trader’s saying “buy on rumour, sell on fact” has materialized as QE3 is now old news.

Overall, we see three signs the U.S. equity market may have peaked, with more downside risk than upside potential in the coming months.

First, when looking at the recent rallies in the S&P 500 over the past two years, there happens to be a significant correlation to Apple Inc. (AAPL/Nasdaq). Specifically, we calculate there has been more than a 90% correlation between the two during what we call Apple-driven rallies.

This makes sense, because the world’s largest company now accounts for nearly 5% of the S&P 500’s total value. The 50% gain in Apple’s share price this year has contributed nearly a quarter of the S&P 500’s 12% gain during the same time frame.

However, the latest Apple-driven rally appears to have run out of steam. Apple’s stock is down approximately 13% from its Sept. 19 high, while the S&P 500 is down only 3% since then.

Another interesting development is the recent dichotomy between oil prices and the S&P 500. Historically, we calculate a strong correlation between the two (at times greater than 70%), which makes some sense as the better the U.S. economy does, the more beneficial it is to West Texas Intermediate (WTI) oil prices. However, this correlation has fallen off a cliff to only 7% since January of this year.

In our opinion, this is telling us either the S&P 500 is properly valued and oil prices are undervalued, or, more likely, oil prices are properly valued and the S&P 500 is overvalued.

Finally, the initial take from third-quarter earnings season, with more than half of S&P 500 companies reported so far, is negative, with fewer companies beating earnings expectations and even fewer beating revenue expectations.

More troublesome is that these disappointing results are coming from large U.S. bellwether stocks such as General Electric, McDonald’s, Google, DuPont and even mighty Apple.

We also see some important uncertainties or risks that lie ahead, such as the economic fallout from Hurricane Sandy, the upcoming U.S. election, and how the U.S. government will deal with the fiscal cliff at year-end.

Weighing all these factors together, we think it’s prudent to take a more cautious and proactive approach to one’s positioning in the U.S. stock market. This may mean a reduction in one’s allocation or at least undertaking some hedging.

Source: FinancialPost.com

 


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