This stock market is running on fumes, but investors are pulling a Kramer. They're continuing to drive the car even though the fuel tank is empty, to see how far they can go.
Not a "Seinfeld" fan? Well, you'll understand this: the stock market is overvalued and poised for a correction. In the holiday-shortened week ahead, here are the events that could determine the downturn's timing and severity.
U.S. equity markets closed higher on Friday, even though employers generated fewer new jobs in August than analysts had expected. Employers added 151,000 jobs last month, compared with projections for 180,000 and a gain of 275,000 in July. The unemployment rate stayed at 4.9%.
The monthly jobs report was modest enough to give the Federal Reserve more room to postpone an interest rate hike. Investors had feared that the Fed might raise rates this month, which could undermine the fragile recovery. But with a rate hike probably off the table, investors were cheered.
The Federal Reserve's dithering has been especially beneficial for utility stocks, which benefit from low interest rates. The benchmark Utilities Select Sector SPDR (XLU - Get Report) is up 14.67% year to date compared to 7.11% for the S&P 500 (SPY - Get Report) . Among the most promising utility stocks now, with their gains year to date: Dominion (D - Get Report) (+10.51%); Southern (SO - Get Report) (+10.71%); Duke (DUK - Get Report) (+12.40%); and NextEra (NEE - Get Report) (+18.52%).
With interest rates still at low levels and growth stocks overvalued, high-dividend utilities are an especially attractive hedge right now. When interest rates rise, rate-sensitive investments such as utility stocks favored by yield-hungry investors typically get clobbered. That's chiefly because utilities need money for capital expenditures. As rates rise, their cost of capital increases and it weighs on their share prices. Moreover, safer interest-rate pegged investments such as U.S. Treasuries become more attractive from a risk-reward standpoint.
But economic growth that's only middling and not great is manna for utilities. This "Goldilocks" state of stasis (not too hot, not too cold) is their sweet spot. Growth has been strong enough to sustain revenue and profits, but insufficiently robust to prompt the Fed to rise rates as early as this month.
That's a lucky break for utilities as well as the broader market, because otherwise the seven-year bull market is on weak legs. Particularly worrying: meager corporate earnings in the context of high stock valuations.
With nearly all S&P 500 companies having reported earnings to date for the second quarter, 70% have reported earnings above the mean estimate and 53% have reported sales above the mean estimate. However, in the face of sluggish economic growth, analysts had kept their expectations low. Results were in actual fact dismal. The blended year-over-year earnings decline for the S&P 500 in the quarter was -3.2%, marking the first time the index recorded five consecutive quarters of year-over-year declines in earnings since the trough of the Great Recession (from the third quarter of 2008 through the third quarter of 2009). For the third quarter, 78 S&P 500 companies already have issued negative EPS guidance.
Despite weak corporate earnings performance and middling economic growth, investors continue to bid stocks higher. The forward 12-month price-to-earnings (P/E) ratio for the S&P 500 is 16.9, compared to the 10-year average of 14.3.
The second-quarter earnings season is mostly over, with only a few major retail stocks remaining on the docket: Barnes & Noble (BKS - Get Report) and Restoration Hardware (RH - Get Report) (Thursday) and Kroger (KR - Get Report) (Friday). Only Kroger is expected by analysts to post a positive report, with estimated earnings per share (EPS) of 45 cents compared to 44 cents in the same quarter a year ago. BKS is expected to post a loss of 13 cents per share, compared to a loss of 28 cents last year. RH is estimated to post EPS of 29 cents versus 85 cents.
This week, major economic reports include Gallup U.S. Consumer Spending, PMI Services Index, Labor Market Conditions (Tuesday); MBA Mortgage Applications, Gallup U.S. Job Creation Index (Wednesday); Jobless Claims, Consumer Credit, and Bloomberg Consumer Comfort Index (Thursday).
Postscript: in the aforementioned TV episode, Kramer eventually gets stranded by the side of the road.
How many times have you heard someone on CNBC say, "I actually think the economy is fine here in the United States. Buy stocks!"? If you're like many Americans, you've probably heard it more than once. But just because they're saying it, doesn't make it true. Because I can tell you with absolute certainty it's not. America is in deep trouble. And the crisis looming on the horizon has the potential to make 2008-2009 look like child's play. The window to protect yourself is rapidly closing. I'll show you how here.