Are stocks set for a spring swoon?
(MoneyWatch) The S&P 500 is off to a hot start this year, gaining more than 12 percent so far andthe first quarter is not even over yet. But if the last two years are any guide, stocks could be poised for a spring slide, says Jeffrey Kleintop, chief market strategist at LPL Financial.
"In both 2010 and 2011 an early run-up in the stock market, similar to this year, pushed stocks up about 10 percent for the year by mid-April," Kleintop writes in a new report to clients. And yet in each of the last two years, the market hit early spring peaks that were then followed by losses of 16 percent to 19 percent -- selloffs that weren't recouped for more than five months.
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Judging by what signs seemed to precede the declines in 2010 and 2011, LPL has identified 10 indicators to watch over the next four weeks that may help forecast whether investors will follow the old Wall Street adage, "Sell in May and go away":
1. End of Fed stimulus. In each of the past two years, Federal Reserve fiscal stimulus programs known as QE1 and QE2 came to an end in the spring or summer and stocks began to slide until the next program was announced. The current program known as Operation Twist is scheduled to conclude at the end of June. The stock market may again begin to slide until another program such as QE3, the scope of which was recently hinted at by the Fed, is announced.
2. Economic surprises. The Citigroup (C) Economic Surprise index measures how economic data in the U.S. fared compared to economists' expectations. The index moved to what has historically marked the peaks in optimism about a month or two before the peaks in the stock market in 2010 and 2011. This year, it appears the index may have already started to retreat from a peak since early February; if this index again leads by two months, the slide may soon begin.
3. Consumer confidence. In 2010 and 2011, early in the year the daily tracking of consumer confidence measured by Rasmussen rose to highs last seen on Sept. 5, 2008, just before the stock market collapse as the financial crisis erupted. The peak in optimism gave way to a sell-off as buying faded. This measure of confidence is once again close to the highs seen in early 2010 and 2011. LPL will be watching for a turn lower in the index that would indicate the start of an erosion of confidence.
4. Earnings revisions. The first couple of weeks of the first quarter earnings season (April 2010 and April 2011) drove earnings estimates higher in both 2010 and 2011. Earnings estimates for S&P 500 companies over the next year rose a greater-than-average 3 percent to 5 percent over the first couple of weeks of reports. But as the second half of the earnings season got underway in May 2010 and May 2011, guidance disappointed analysts and investors as the pace of upward revisions declined sharply. This year, LPL will be watching to see how much earnings expectations rise as the initial reports come in and if they begin to taper off sharply.
5. Yield curve. In general, the greater the difference, or spread, between the yield on the 2-year and the 10-year U.S. Treasury notes, the more growth the market is pricing into the economy. This yield spread, sometimes called the yield curve because of how steep or flat it looks when the yield for each maturity is plotted on a chart, peaked in February of both years at 2.9 percent. Then the curve started to flatten, suggesting a gradually increasing concern about the economy.
6. Oil prices. In 2010 and 2011, oil prices rose about $15 to $20 a barrel from around the start of February, two months before the stock market began to decline. This year oil prices have climbed back to the levels around $105 to $110 that they reached in April of last year. A further surge in oil prices would make this indicator more worrisome.
7. The LPL Financial Current Conditions Index (CCI). In 2010 and 2011, LPL's index of 10 real-time economic and market conditions peaked around the 240-250 level in April and began to fall by over 50 points. This year, the CCI recently reached 249 and has started to weaken and currently stands at 232.
8. The VIX volatility index (investor fear gauge). In each of the past two years the VIX, an options-based measure of the forecast for volatility in the stock market, fell to a relatively low 15 in April. This suggested investors may have become complacent and risked being surprised by a negative event or data. This year, the VIX has recently declined once again to 15 in the past two weeks.
9. Initial jobless claims. It was evident that initial filings for unemployment benefits had halted their improvement by early April 2010, and beginning in early April 2011, they deteriorated sharply. So far, in 2012 initial jobless claims continue to improve at a solid pace, but it may yet be too early, and so LPL will be watching for any weakening as April gets underway.
10. Inflation expectations. The University of Michigan consumer survey reflected a rise in inflation expectations in March and April of the past two years. In fact, in 2011, the one-year inflation outlook rose to 4.6 percent in both March and April. This year, inflation expectations have also jumped higher so far in March, reaching 4 percent.
"So far, about half of the 10 indicators point to a repeat of the spring slide this year, while the other half do not," Kleintop says. "Given this year's double-digit gains and the possibility of another spring slide for the stock market, investors may want to watch these indicators closely for signs of a pullback despite the current upward momentum in the stock market and solid economic growth."