Why Don’t Markets Rebound?

The S&P 500 closed yesterday at 1309, down well over 1%. The NASDAQ closed down nearly 2%. In light of relative valuations and current global prospects for the past six months, the question begs an answer: Why the downward action?  Let’s begin with an overview of the results of the past week.

Last week lacked catastrophically bad news. China lowered its prime interest rate to combat its slowing growth. The world continued to wait for a solution to Europe’s worst problems, currently formulated (but don’t hold your breath) as a proposed infusion of $125 billion into Spain’s banking system, which if consummated, should stabilize Spain and leave the Greek election on June 17 as the worst potential problem on the European front for now. Other than a very poor Factory Orders report a week ago Monday, the remaining domestic economic reports were slightly below expectations but nothing particularly troubling.

The lowering of China’s prime interest rate, the European positive rumors, and no really bad economic news domestically resulted in a robust market that gained from 3 to 4%, depending on your favorite index.

Market Stats. Especially bullish among style/caps was Small-cap Growth, leading the way with a 4.74% gain for the week. Even the worst style/cap Mid-Cap All, was strong at +3.50%. Due to the European rumors, Financials was the leading sector up a strong 4.91%; while it gained about 20% since its October 2011 low, it’s still 15% below its early 2011 high and less than 50% below its 2007 high.

Other strong sectors included Technology, Cyclical Consumer, and Basic Materials. Telecom, one of the previous week’s leaders was the worst, but with a gain of 2.6%. All in all, the market’s performance was quite bullish with the S&P 500 closing at 1326, well above its 1260 support level. For scorekeepers, that is about 100 points below the high in early April.

Despite a new economic report showing a continued slowdown in retail sales, the Asian markets reacted favorably to the infusion for Spain Sunday. The Nikkei closed up 2%, and the mainland Shanghai Composite closed up more than 1%.

The European bourses opened yesterday, as expected, in very strong fashion. Oil prices advanced, as did gold. But amidst the euphoria, questions began to arise about exactly what the Spanish request really meant with regard to Europe as a whole. Concerns swarmed over whether Greece would be more likely to vote against austerity views in the election of June 17, following Spain’s request. If Spain need not bear severe austerity measures, then why hadn’t Greece been treated similarly?  Without trying to sort out the rationale, the bourse's prices began to retreat, as did oil prices and gold.

Domestic U.S. markets opened yesterday morning in a positive although restrained manner, opening up nearly 10 S&P points, or nearly 1%. But the muted response here seemed to reinforce the growing concerns in Europe. The CRB prices fell, and soon oil and gold were down, not up. The euro fell back below the U.S. dollar despite its early rally. The FTSE closed down slightly and the German DAX closed up but only by 0.17%. The rest of Europe was mixed. As noted in our opening, the US markets steadily fell throughout the day albeit on fairly light volume.

It is very hard to draw sweeping conclusions from yesterday other than it wasn’t what most expected.

Regarding valuations, the Sabrient GARP (Growth at a Reasonable Price) 100 is at better valuations than in late September 2011 when the S&P 500 traded at prices near 1100. The GARP 300 is near the same valuation of that period. The GARP 1000 is a bit higher than valuations of September 2011 but well below the valuations in May 2011 when the market traded near current levels. Next quarter’s expected quarter-over-quarter earnings growth is priced a little higher than September but lower than May. And longer term valuations such as the 5-year PEG for the GARP 100 and GARP 300 are actually almost as low as they were in March 2009!

So clearly, it is not a valuation issue based on corporate earnings health unless a fairly severe downturn in global activity is foreseen. We will get peeks at the changes in our economy this week with Retail Sales and Business Inventories on Wednesday, Initial Jobless Claims on Thursday, and the important Industrial Production along with Michigan Consumer Sentiment on Friday. Export/ Import prices, PPI, and CPI also are reported this week, but no one seems very worried about inflation at this point (famous last words).

We suggest caution, with a lot of opportunities for bargain hunting but a need for hedges using the European ETFs we have provided in the past few articles. Probably the VGK would be best now or a euro hedge such as the FXE.

4 Stock Ideas for this Market

This week, I used the GARP preset search in MyStockFinder, including only Small-cap stocks. Here are four you may find interesting:

Cascade Corp. (CASC)—Cyclical Consumer
C&J Energy Services, Inc. (CJES) — Energy
Globecomm Systems Inc. (GCOM)—Technology
Kapstone Paper and Packaging Corp. (KS)—Basic Materials

Full disclosure:  The author does not hold positions in any of the stocks mentioned in this article.