Over the last few weeks, we’ve seen the S&P 500 hit a new all-time high at 1,897. And we’ve seen an as-yet unfinished 4% correction.
Now, I often use Yahoo! Finance to monitor intra-day market action. (Of course, because Yahoo’s numbers aren’t always reliable, I do my own research with 10Qs and 10Ks.) But Yahoo! is just for stock watching — for entertainment purposes only.
Just yesterday, in what has to be one of the stupidest statements I’ve ever seen, some analyst guy told Yahoo! Finance that you can’t use traditional value metrics for electric car company Tesla (NASDAQ: TSLA).
Some analysts thought it was different for Internet stocks back in 1999 as well. And it was true — until it wasn’t.
Recent Yahoo! Finance headlines have declared, “Stocks CRUSHED Again!” and asked, “How Far Will this Correction Go?”
With any financial media (with the, ahem, notable exception of Wealth Daily), it’s important to remember that providing good commentary and research is not the primary objective. Getting you to click on articles so their ad rates are justified is really what they are after.
So the headlines can be a tad inflammatory sometimes…
Stocks CRUSHED again? Well, not so much. The S&P 500 was down 10 points at the time that headline was posted. And all told, the S&P 500 is off ~4% from its highs. Sorry to disappoint, but that does NOT count as CRUSHED!
To put it in context: We’ve already seen a 7% correction this year that took the S&P 500 down to 1,750. At the risk of tempting fate, the current 4% drop barely qualifies as a correction.
What we have been seeing (so far, at least) is a controlled burn of momentum stocks. Small caps, biotech, and some tech stocks have been hit hard. The average trailing P/E for the small-cap stocks in the iShares Russell 2000 ETF (NYSE: IWM) was over 20.
At its highs, the iShares Nasdaq Biotechnology ETF (NASDAQ: IBB) carried a trailing P/E of 30 and traded 7 times book value.
No doubt about it, these sectors were expensive.
But the rest of the stock market is fairly valued. And we could argue (not that we’re the confrontational type) that dividend stocks like REITs may even be cheap compared to the 10-year yield.
Thanks, Dr. Ed!
Way back in the day, Ed Yardeni used to be the head economist at Prudential Securities and EF Hutton, and he moved on to become Chief Investment Strategist for Deutsche Bank. Now, he provides independent research to institutional investors and writes an exceptional blog called “Dr. Ed’s Blog.”
He recently took a look at the Nasdaq, checking percentage declines and P/Es. What he found was that the highest P/Es suffered the biggest declines, while low P/E sectors actually rallied a bit:
Internet Software & Services (-13.4%, 23.9), Application Software (-12.2, 36.1), Data Processing & Outsourced Services (-6.6, 19.7), Communications Equipment (1.9, 12.9), Systems Software (2.1, 13.5), Semiconductors (2.9, 14.9), and Semiconductor Equipment (4.8, 15.2).
(2) Health Care. Now let’s do the same for the S&P 500 Health Care sector, which is down 4.1% since March 5 through April 7: Health Care Technology (-12.9%, 32.7), Biotechnology (-12.4, 20.3), Health Care Distributors (-7.1, 16.5), Life Sciences Tools & Services (-5.7, 17.0), Pharmaceuticals (-2.8, 16.8), Health Care Services (-2.5, 15.1), Health Care Equipment (0.5, 16.1), and Managed Health Care (2.7, 12.8).
This supports our contention that we are seeing a “controlled burn” correction. The question at this point is: will this correction spread?
Corrections usually begin with momentum names, but they can spread to the rest of the stock market. Is that what’s about to happen?
Taxes and Earnings
There has been some speculation that this controlled burn is tax selling. After a phenomenal year in 2013, the logic goes, investors are having to sell some stock to raise cash for capital gains taxes.
It makes sense, but there’s no way to verify that this is what’s happening. So let’s have a look at a quantifiable catalyst: earnings.
As we have reported, 2014 was expected to be a big year for S&P 500 earnings. After posting a record $107.45 per share in earnings last year (2013), the S&P 500 was expected to put up around $120 a share this year as U.S. GDP growth accelerated.
But that was before the polar vortex brought many areas of the country to a standstill and sucked up a higher percentage of discretionary income via higher heating bills.
Since the beginning of 2014, first-quarter earnings estimates for the S&P 500 have dropped from a 4.4% gain to just 0.3%. To reinforce the weather thesis, the Materials sector (building stuff) has seen the biggest downward revision, from 9.1% to 0.3% growth. Materials is followed by Consumer Discretionary (stores and restaurants), where estimates fell from 12.8% growth to 4.4%.
So, including the Q1 revisions, here’s what analysts are currently expecting for earnings growth:
At this point, obviously, analysts see Q1 earnings as an anomaly. And it may well be that analysts have overshot with lowered revisions…
As we write, 29 S&P 500 members that have reported earnings are up 3.2% from the same period last year. 58.6% of these companies have beaten expectations. Total revenues so far are up 2.4%, and 38% have beaten on revenues.
If this trend continues, then this controlled burn correction that has taken ~4% off the S&P 500 is likely nearing an end.
Right now, I’m watching stocks that have stayed strong through the controlled burn. Kodiak Oil & Gas (NASDAQ: KOG) is one. Alcoa (NYSE: AA) is another. If you like fat dividends, Annaly Capital Management (NYSE: NLY) has been strong and pays 10.5%.
I’m also buying a small natural gas stock that’s run from $5.10 to over $6 as the market has sold off. I think this stock could be worth $14.50 this year.
Until next time,
Briton Ryle
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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.
