Stocks have had a fantastic start to the year with many indices making multi-year highs. But now that the euphoria of the New Year is over it is worth taking a look at the fundamentals to see if there is any more steam left in this rally.
Why Apple’s results may not be a warning sign for the market
Poorly received results from Apple on Wednesday managed to weigh on market sentiment. Apple shares slid 10% yesterday after the company reported no rise in profits and missed iPhone sales forecasts of 50 million for Q4, instead “only” selling 47.8 million. These are still huge numbers, however when you are the world’s most valuable company the bar is quite high and an earnings miss can cost the company $50 billion, which is the dollar equivalent of the 10% drop in the Apple stock price last night. While Apple may have found a bottom (below $500 the stock starts to look oversold), constantly impressing investors and analysts with new products and stellar profits will get harder for Apple’s top brass in the coming quarters.
But what impact does this have on retail traders? If you trade stocks or the major stock indices then it’s worth keeping an eye on what the world’s largest company is doing for two reasons: firstly, as movements in their stock price can have an impact on an entire index; secondly, Apple is a major consumer goods company and it can give a good indication on the strength of the global consumer and also the potential for economic growth going forward. In this instance, one of the reasons why Apple’s sales were down was because of greater competition in the smart phone and tablet space, which is eroding Apple’s market share. Apple’s loss can be another company’s gain, after the announcement of Apple’s results, Google, maker of the Android smart phone, saw its share price surge nearly 7%.
Overall, Apple’s share price rise in 2012 was stunning, it is now returning to a new normal where growth is moderate and Apple’s golden touch, while not completely lost, is diminished as its competitors catch up.
Q4 earnings season:
Earnings data so far (about 20% of S&P 500 companies have announced earnings for Q4 at the time of writing) has been quite encouraging. So far for the 115 companies on the S&P that have reported earnings, sales data has beaten estimates by nearly 1%, while earnings have beaten estimates by more than 5%. This is better than Q3 2012 when sales growth failed to reach estimates and earnings growth was down for all securities in the S&P 500. The trend is similar for the Dow Jones. The nasdaq has had a harder time. So far a quarter of companies on the Nasdaq have reported results, although sales have missed estimates, earnings growth has been stronger.
It’s early days in the earnings season (Europe hasn’t even got under way yet), but apart from some high profile casualties, the results have been encouraging, especially as some thought that analyst estimates for 2012 were too high. This could boost investor sentiment and may fuel continued flows into equities and out of safe haven assets in the coming months.
The question to ask now is what will 2013 earnings and sales look like? That will depend on two factors in our view:
1, a low cost of capital for corporations (i.e., interest rates need to remain low)
2, continued improvement in the growth outlook.
On the second point, we have seen signs that Europe is coming back to life. January PMI data was stronger than expected, and although it remains in negative territory it suggests that the Eurozone economy is starting to stabilise. This needs to feed through to employment data in 2013 so that this important market for global companies starts to perform once again.
China is also experiencing signs of a pick-up; its PMI data for January also beat expectations suggesting that the government-induced growth slowdown in 2012 is coming to an end.
So from a fundamental perspective there are signs of optimism for US stocks in the months ahead. But it’s not just about fundamentals; technical analysis also plays a part for retail traders.
The technical perspective: can the rally last?
There are a few lead indicators in the stock market that it is worth keeping an eye on. We will take a look at two of them here: the Dow Jones Transport index and the Russell index. The Transport index is considered a lead indicator because when the economy is strong transport companies should be busy moving goods around the country/ world, which should boost their stock prices and vice versa. The Russell is an index of 2,000 small companies, when risk appetite is strong small companies tend to do well. Thus, to be confident that the rally in the Dow and the S&P will be sustained we would want to see a strong transport sector and small company share prices doing well.
As you can see in the chart below, these indices are both at elevated levels, in fact the two indices are at record high levels.
Figure 1: Dow Jones transportation average and the Russell 2000 index
