Reviewing Equity Market Momentum - Zacks Investment Research

Stock markets sold off in May through early June, then recovered to the 1350 level on the S&P 500 at June?s end.? In early July, we traded sideways, volatile and range-bound around 1350.? Then, stocks rose smartly.

Q2 earnings season for S&P 500 companies showed us earnings reports that were weak, particularly on the revenue side.? So we did not find it surprising to have another ?Muddle Through? reading for Q2 GDP at +1.5%. In sum, we learned there is a +3% to +4% nominal domestic GDP growth rate available for revenue growth. That?s what we heard from the big companies in Q2 on revenue growth, broadly-speaking on their top lines.

One added ?big picture? data item for bulls? Q4-11 real GDP growth was revised to +4.0%. That's an upward surprise.? After the late summer 2011 panic over Europe and a holdback, U.S. real GDP actually went up smartly.? Are we here again in the late summer of 2012?

We universally think a forward-looking conversation on GDP growth should be foremost in investor?s minds.

In our best-case scenario, we can get added strength from places like China and India, now that their monetary and fiscal authorities are shifting to easing from a lengthy period of tightening.?? Europe can get needed liquidity.? U.S. housing and construction momentum can improve further.

Our fear, which is built into our worst-case scenario, is that it gets worse.? Many investors could assume ?recession? with the approach of a stall-speed type of GDP growth scenario. And a recessionary outlook = falling stock prices.? Stocks might only go up swiftly and meaningfully AFTER the above stall-speed scenarios fail to bear out after a quarter or two.

For example, what does the U.S. real GDP growth outlook look like from a base of +1.5% when you subtract out a ?Fiscal Cliff? at an assumed -0.4% to -0.8% rate next year? Or if you add in any further deterioration of growth in Europe and its ripple effects to the U.S. and global economies? It may be positive U.S. real GDP growth of +0.1 to +1.0%. Better than a recession.? ?

Getting back to our base-case, one noteworthy thing about the last few weeks equity rally is the really low volatility. This is not like anything visible in the past few years.? It speaks to a steadier and more gathered consensus about earnings, and the diminishing possibility seen of big threats, at least in the minds of those who participate in equity markets. ?

We are beginning to think that the flattening of the S&P 500 profit margin in the last quarter had the unexpected benefit of tightening up the consensus.

Take a look at the S&P 500 Sector chart below for another key top-down investing insight.? This shows the 12-month forward P/E ratio over the Zacks consensus 3-5 year EPS forecast growth rate for each S&P 500 Sector. ?

Zacks? Conclusion

The year?s high equity risk premium environment has driven investors to bid up Telco and Utility sector earnings multiples in excess of their forecast earnings growth.? Compelling evidence of institutional investor?s search for yield, preservation of capital, and earnings stability in the current modest growth rate, and, at times, turbulent fundamental environment.

In summary, Europe?s spreading recessions and its volatile debt markets are core elements holding U.S. stocks back at times.? However, heavy selling of S&P 500 stocks cannot be blamed solely on the various European predicaments.? Weak U.S. macro numbers have been part of the mix.

What keeps up a floor and raises optimism?

Seven months of strength flowing from the U.S. housing market and from U.S. construction, both for the first time in five years.? The Achilles heel is no more.

Is It Time to Buy in Late August? ?

Looking out 6-12 months, Zacks in-house strategists see the S&P 500 as being +5% to +10% higher. In fact, it could be well above the previous high of 1420 a year from now. ?

If a turbulent and murky environment re-asserts itself, we could see -5% to -10% downside moves before sentiment on world stock markets and risk-taking improve. With more fundamental domestic support and successful European interventions, though, stocks will go higher.

READ OUR FULL ZACKS MARKET STRATEGY REPORT HERE.

Source: http://www.zacks.com/stock/news/81825/reviewing-equity-market-momentum

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