Four reasons we’re still cautious about the market

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John Hintz Photo - resized for HubspotAfter posting negative returns in the months of December, January, and February, we have experienced a significant counter-trend rally in the stock market since mid-February.  The bulls are reading this as a sign that the seven-year long bull market has regained its footing.  We are not as confident in that assessment and see this as a mini run-up in the broader context of an overall bearish market.  This fall we wrote a post about why, at the 2,100 level on the S&P 500, we were cautious.  Since then, we had a deep correction in the stock market followed by a sharp rally that takes us to today’s level of approximately 2,050.  While the market is a bit lower than the 2,100 level where we initially blogged about key market risks, we reiterate our cautious view and hesitancy in chasing the short term upside volatility in the stock market.  This brief list of fundamentally-based facts illustrates the reasons for our continued cautious stance towards the stock market:

  • Stocks are expensive – the S&P 500 is currently trading at a lofty 16.7x price to earnings multiple. This compares to the 10-year average multiple of 14.0x.
  • Sales growth and earnings growth are negative (we are in a revenue and earnings recession). Corporate America just finished reporting calendar year’s 2015 fourth quarter results.  Companies provided guidance for Q1 2016 and the outlook is not very enticing.
    • The S&P 500 is forecast to post year-over-year sales growth of negative .8% in the first quarter of 2016.
    • The S&P 500 is forecast to post year-over-year earnings per share growth of negative 8.3% in the first quarter of 2016.
  • Profit margins have peaked and are starting to decline.
  • Total debt to total capitalization (financial leverage) is starting to increase.

It is clear that the fundamental data is contradicting the short term rally we have seen in the stock market.  It is hard to be bullish when sales growth is negative, earnings per share growth is negative, profit margins are being squeezed lower and financial leverage is increasing.  International economies are facing even tougher environments than the U.S.

We continue to feel cash is king until the four factors listed above start to improve.  We either need to see better financial operating conditions in corporate America or stocks trading closer to historical valuations before we get excited about stocks once again.  We have recently uncovered some investment selections with attractive outlooks and have purchased them for our portfolios.  However, until these opportunities become more widespread in the market, we continue to emphasize protection of principal and to wait for more investment opportunities with more favorable risk/reward characteristics.