Surprise No. 2: The 2013-2014 earnings cliff sinks the markets in 2013's first half.
- The investment narrative shifts from fiscal cliff concerns to earnings and margin cliff worries.
- Slowing economic growth and lower margins pressure corporate profits and S&P 500 earnings drop to $95-$97 a share, well below consensus.
- Real estate activity and home prices flatten out.
- Retail sales are conspicuously weak.
- The stock market puts in its yearly high in the first two weeks of January.
- A Tale of Two Cities: a down stock market in the first half and an advancing stock market in the second half.
- The S&P 500 range for year 2013 is 1275-1480 and closes the year flat (just as it did in 2011).
The 2012 improvement seen in the residential real estate markets moderates, as sales activity/turnover and home price appreciation flattens.
Already refinancing applications (-23%) and new mortgage applications (-15%) have taken a bad fall in the last half of December 2012. Low interest rates from 2009-2012 have done their job in reviving the U.S. housing market, and that stimulus should be seen as bringing forward home sales -- now it is up to the domestic economy to resuscitate demand.
On the latter point I am less optimistic about the foundation of growth for the U.S. economy and the financial fate of the consumer who is now just absorbing a new tax hike (see surprise No. 1). Finally, let's not lose sight that the Obamacare surcharge of 3.8% will be applied to home sales in 2013.
Retail sales suffer, as spent-up not pent-up consumers are stunned by having less money in their wallets.
In 2013 we discover that there is a limit to the consumer in the face of our dysfunctional leaders' inability to deliver a grand bargain. A payroll tax increase, higher top income tax rates and the Obamacare surcharge, coupled with disappointing capital spending and weak hirings, represent the brunt of the domestic growth shortfall relative to consensus expectations.
Surprisingly, automobile sales, benefiting from pent-up demand (much like housing last year) continue to improve slowly, to a surprisingly strong 16 million-17 million SAAR rate by year-end, and represent a standout feature of the domestic economy throughout the new year.
Wage growth is muted, interest rates remain low, and inflationary pressures are nonexistent, helping to keep profit margins from slipping too far. Nonetheless, slowing domestic economic growth and reduced final demand -- personal consumption expenditures are further hurt by the droughts and rising food prices -- weigh significantly on corporate profits.
Full-year 2012 S&P 500 earnings come in at $102 a share, while 2013 S&P profits disappoint at $95-$97 a share, well below consensus of about $106-$108 a share, top-down estimates of $107-$109 a share and bottom-up forecasts of $112-$113 a share.
Though starting out strong, the stock market in 2013 is a tale of two cities, with a weak first half and a stronger second half. The 2013 S&P 500 range is 1275-1480. The S&P 500 ends the year flat.
Beginning-of-the-year equity fund inflows, breathless optimism (of a technically inspired kind) and the initial excitement over the fiscal cliff resolution lift the S&P 500 to its yearly high in the first two weeks of January 2013. Unfortunately, the lack of intelligent, thoughtful leadership becomes ever more apparent in February-March, and ultimately the S&P 500 bottoms at about 1275 (or at 13.5x my projected S&P profit surprise) during the spring.
The VIX exceeds 25, and risk premiums remain elevated amid the increased political rancor.
While dividend payout rates are low and corporate balance sheets in strong shape -- there is less than meets the eye here as it should be noted that much of the cash hoards are positioned in non-U.S.-taxed overseas accounts -- a smaller amount of money is returned to shareholders as dividend growth and share buybacks slow down as business confidence ebbs and the economy decelerates.
Though most believe that a spending deal will be forced by the pressures of a weakening stock market and economy, there is no agreement or real addressing of the deficit forthcoming despite a slide in equities and the backdrop of falling corporate profits and weaker economic growth taking center stage.
In the second half of 2013, coincident with a slow improvement in domestic growth, the market stages a persistent recovery back toward year-end 2012 levels of 1425 (as investors get inured to the political dysfunction and grow increasingly accepting of a period of slowing secular economic growth), exactly duplicating the flat market experience of 2011.
The VIX falls back under 15 by the second half of the year.
I would emphasize that a flat year in the U.S. stock market is a much rarer occurrence than many would think. According to The Chart Store's Ron Griess, in the 84 years since 1928, when S&P data was first accumulated, the index was unchanged in only two years (1947 and 2011). In only four of the 83 years was the annual change in the S&P 500 under 1%: 1947 (0.00%), 1948 (-0.65%), 1970 (+0.10%) and 2011 (+0.0%).
: Buy index puts in the first half of 2013; short Market Vectors Retail ETF (RTH)