Chasing Yield in Stocks

Investor’s first read – Daily edge before the open
DJIA: 17,918
S&P 500: 2,099
Nasdaq Comp.:4,859
Russell 2000: 1,147
Thursday, July 7, 2016 9:02 a.m.
CHASING YIELD – wherever it can be found !
Fed policy and Brexit’s flight to safety depressed the 10-year U.S. Treasury yield yields 1.32%. yesterday, before a rally this morning brought it back up to 1.39% along with 10-years in most European countries.
Buying bonds under these conditions carries a huge risk, knowing how fickle the Fed has been. One reference to rate hikes by one of its Governors out on the speakers’ circuit, or a rumor the Brits won’t exit after all and whoosh, down goes the price of long-term bonds.
Record low interest rates has left money managers little choice but to buy blue chip stocks yielding yields north of 2%, and part of the buying in recent months has been just that.
But that alone won’t prop the market if the Street factors in Q2 earnings which will be much lower than projected three months ago, or the uncertainties arising of the November elections.
What’s more, a stronger U.S. dollar stands to adversely impact Q3 and Q4, S&P 500 earnings, which the Street was counting on to justify these prices.
Earnings projections for Q2 call for a drop of 5.3% vs. an estimate of a drop of 2.8% three months ago. While oil and related industries account for much of this decline, nine sectors have lower growth rates now than at Mar.31. This would bring the P/E for the S&P 500 to 16.4 compared to a 5-year average on 14.6 (data A Q2 decline would be the first time Y/Y earnings have declined five consecutive quarters since Q3 2008 – Q3 2009, the Great Recession.
Earnings will be released in coming weeks. Along with that, the Street will have to deal with revisions of future earnings and corporate guidance. Expect those to be lower than projected.
The truth is the Fed is successfully micromanaging stock prices.
One of the first rules I learned in this business years ago was, “Don’t fight the Fed.” No one has as much clout as the Fed.
Unfortunately, it looks like the Fed has painted itself into a corner.
Q2 earnings will come out in coming weeks and will stink. The prospect for Q3 and Q4 will likely fall short of projections.
If the market takes a hit, the Fed will simply hint of no interest rate increase before 2018 instead on one bump. If things get even worse (economy, politics, another exit from the EU, the Fed will hint of an interest rate decrease.
What this does is inflate market values, already over valued – a BUBBLE !
Once it becomes obvious low interest rates have no positive effect on the market it will adjust sharply to a realistic level that discounts weak earnings, a prospective recession, a host of corporate bankruptcies, and rising unemployment.
Most likely that “adjustment will be straight down like August and January, with a much longer recovery.
The Street is convinced the Fed will keep interest rates at sub-normal levels, and will buy stocks that offer a 2% – 4% yield. These are the big blues and dominate the market averages.
Can this buying have the oomph to run the market to new highs ?
Yes !
Is there a high risk of chasing stocks with the S&P 500 up 215% over 7 years ?
Yes, especially since the S&P 500 sells at an inflated P/E with earnings on the decline. What is the sense of receiving a 3.5% return if your stock declines 15% – 30% ?
The ADP Employment Report today for June showed the economy gained 172,000 jobs versus projections of 150,000. Tomorrow, we get the Employment Situation report which stunned the Street last month with only 38,000 jobs gained.
The ADP report did not forecast that poor number, so we will have to wait until tomorrow at 8:30 for a better read.
SUPPORT “today”: DJIA:17,856 , S&P 500:2,091; Nasdaq Comp.:4,833
RESISTANCE “today” DJIA:17.998; S&P 500:2,108; Nasdaq Comp.:4,881
On occasion, I technically analyze each of the 30 DJIA stocks for a reasonable risk, a more extreme risk, and an upside potential over the near-term. I add the results of each, then divide by the new DJIA “divisor” (0.14602) to get the DJIA for those levels. This gives me an internal check on the DJIA itself, especially if certain higher priced stocks are distorting the averages.
As of July 1, 2016, a reasonable risk is 17,798 a more extreme risk is 16,833. Near-term upside potential is 18,120.
(I will repeat this regularly to keep readers aware of the potential for an April correction)
The market is tracking a pattern for presidential election years where an administration is in its second term.* The news is bad.
Historically, these markets have declined in Jan./Feb., rallied in March then topped out in early April, plunged in May with brief rallies in June and August and a plunge into October prior to the election.
 STATUS OF MARKET: Neutral – but very, very vulnerable. Expect volatility
 OPPORTUNITY: RISK: Risk high, Profit taking justified.
 CASH RESERVE: 45%. Consider 75% now if tolerance for risk is low.
 KEY FACTORS: Outlook for Q2, and 2016 earnings questionable. Fed has market under its spell.
Note: Source of weekly economic calendar and good recap of indicators:
George Brooks
Investor’s first read
A Game-On Analysis, LLC publication
Investor’s first read, is a Game-On Analysis, LLC publication for which George Brooks is sole owner, manager and writer. Neither Game-On Analysis, LLC, nor George Brooks is registered as an investment advisor. Ideas expressed herein are the opinions of the writer, are for informational purposes, and are not to serve as the sole basis for any investment decision. References to specific securities should not be construed as particularized or as investment advice as recommendations that you or any investors purchase or sell these securities on their own account. Readers are expected to assume full responsibility for conducting their own research pursuant to investment in keeping with their tolerance for risk.

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