July 17, 2013 | By Scott Minerd, Global CIO
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.
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.
Source: Bloomberg, Guggenheim Investments. Data as of 6/30/2013.
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