A U.S. Stock Market Rally to Sell

The longer-term outlook for the U.S. stock market remains favorable, but moves in the NYSE advance/decline line suggest caution in the weeks and months ahead.

July 17, 2013   |    By Scott Minerd, Global CIO

Global CIO Commentary by Scott Minerd

I hold a bullish long-term view of equities as an asset class, but it appears the stock market is in for a rough summer. One of my favorite indicators is the New York Stock Exchange advance/decline line (NYSE breadth) which is calculated by taking the difference between the number of advancing and declining stocks in the equity index. In the most recent equity market decline, NYSE breadth dropped more than equity prices, which can indicate a larger sell-off coming in the near- to medium-term. Although equities have recently rallied, mature markets often exhibit this type of behavior as they come closer to topping. The current outlook for equities has parallels with the trajectory of stocks in 2007.

In that year, breadth turned down by 17 percent in February, while the Dow Jones Industrial Average only declined 6 percent. Although equity prices then enjoyed a brief rally in the spring, the divergence foretold further downside risk, which materialized in July of that year when equity prices collapsed by nearly 10 percent. A similar pattern could be playing out today. The oversold position in the stock market last month and declining market breadth seems to indicate that, while equities are now enjoying a rally, investors should view it with caution. This is a rally to sell, not to buy. Given the deteriorating technical indicators and worrying signs in the global economy and particularly in China, it is likely that stocks will see more damage before the end of the summer.

 

Deteriorating U.S. Earnings Expectations

The deterioration of earnings pre-announcements from U.S. companies highlights an increasing concern over the sustainability of the recent growth in corporate earnings. By June 30, 87 S&P 500 companies had issued negative second quarter earnings guidance, whereas only 21 companies had issued positive guidance, suggesting slower earnings growth ahead. The ratio of positive-to-negative guidance has declined to its lowest level since the start of the current bull market in March 2009.

In combination with a strong dollar and rising concerns over a slowdown in China, this suggests corporate profits could be disappointing. During the second quarter, companies with the highest exposure to China significantly underperformed. If China’s economic growth continues to slow, the sell-off in U.S. equities could significantly increase.

S&P 500 NEGATIVE AND POSITIVE EARNINGS PRE-ANNOUNCEMENTS

CUMULATIVE NYSE ADVANCE/DECLINE LINE AND THE DOW JONES INDUSTRIAL AVERAGE

Source: Bloomberg, Guggenheim Investments. Data as of 6/30/2013.

Economic Data Releases

Retail Sales Weaken While Prices Rise on Energy

Europe PMIs Indicate Expansion as Confidence Improves, China Slows Further

Important Notices and Disclosures

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. This article contains opinions of the author but not necessarily those of Guggenheim Partners or its subsidiaries. The author’s opinions are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC. ©2014, Guggenheim Partners. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.


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