It’s an old market maxim that the stock market often climbs a wall of worry.
In the current rally the S&P 500 has gained 29% since its October low, and the wall of worry it climbed has been impressive. Reports in October showed the economic slowdown in the first half of the year worsened in July and August even as the 2nd half got underway. By November the eurozone debt crisis and fears of a potential default by Greece, and an ugly aftermath, were dominating headlines.
The market had a great time scrambling up that wall of worry.
In the last month or two those worries have gone away. However, to the extent that the market needs one, the good news is that the overall wall of worry remains in place. Some of its bricks have merely been replaced with others.
Worries about the slowing U.S. economy and eurozone debt crisis have been removed, but have been replaced by slowing economies in Europe and Asia, and rising oil prices (a situation that in the past has often snuffed out economic recoveries and bull markets). And there are even early signs of potential rising inflation, which for three years ‘big picture’ theorists have been expecting from the easy money policies used by global central banks to pull global economies out of the Great Recession.
So there is no problem with that wall of fundamental economic worries. It’s still there if the market needs it. A few bricks have been changed out, others swapped in. But it remains intact.
Another load of bricks for that wall may even be rumbling down the road in the form of 1st quarter earnings reports.
Corporate earnings have been a wonder to behold in recent years. The driving force was relentless cost-cutting during and after the ‘great recession’ to bring costs in line with plunging sales and anemic demand. Plants were closed, millions of workers were let go. Remaining employees worked harder to keep up, so productivity picked up significantly. Lower costs and higher productivity resulted in sharply rising earnings in spite of the anemic economic recovery.
That virtuous cycle is coming to an end. There are only so many areas where costs can be cut, and those have been quite thoroughly exploited. And now payroll costs are rising again and productivity is softening. The former can be seen in the impressive big jump in employment over the last four months, while recent reports indicate productivity is slowing toward normal.
Rising payroll costs and softening productivity means it costs more to produce products. The question then becomes have companies been able to raise their prices enough in this still anemic recovery to offset those rising costs, or will earnings suffer.
We should know in a few weeks as first quarter earnings begin to be reported, and possibly sooner since corporations usually issue warnings and lower guidelines if they expect to miss forecasts, giving Wall Street firms time to lower their estimates so even disappointing earnings will still ‘beat the forecasts’.
So there are more than enough bricks to keep that wall of fundamental worries intact. And markets repeatedly demonstrate they can climb that kind of wall.
However, a real problem for the market may be developing in the form of a different kind of wall of worry that has been building for market technicians, and unfortunately just as April approaches and the market nears the end of its traditional favourable season (as in Sell in May and Go Away).
Its bricks include those that cause non-technical eyes to glaze over, like overbought conditions and narrowing breadth, but also the easily understood high level of bullish and confident investor sentiment (often associated with market tops), and unusually high levels of selling by usually savvy corporate insiders (who were buying heavily in November).
A point to consider is that this wall of technical worries may be telling us more about corporate earnings than the wall of fundamental worries, and it is earnings that ultimately drive the market.
That point is, which group is looking ahead, probably knowing more about what their companies will be reporting for 1st quarter earnings, and which group may be merely looking out the rear window, excited to see what has been happening with the market since October.
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