Surprise: Stocks are having a strong year
NEW YORK—For all the scary headlines -- a bailout of Spanish banks, JPMorgan's huge trading loss, the sputtering job market, Facebook's failed initial public offering -- it's a wonder stocks aren't down more this year.
Actually, stocks aren't down. That was a trick sentence. At the halfway mark for 2012, stocks are up more than 8 percent.
"People think we're down because memories are short," says Rex Macey, chief investment officer at Wilmington Trust Investment Advisors. "It feels like the market's been worse than it actually has."
The year began with investors focusing on corporate America's record profits and scooping up stocks. The Standard & Poor's 500 index surged 12 percent from January through March.
It looked like that gain might be wiped out in the second quarter. Investors worried about Europe's inability to find a lasting solution to its debt crisis and about slower job growth in the United States.
Then came Friday: European leaders announced a broad strategy to funnel money into failing banks and keep borrowing costs down for governments, and stocks soared around the world.
It all left the S&P 500 up a healthy 8.3 percent for the year.
What happens next will probably depend on corporate earnings again. For April through June, they are expected to fall 0.7 percent from a year ago, according to S&P Capital IQ, a research firm. That would be the first drop in nearly three years.
So far, though, stocks in the U.S. are trouncing those in many countries. European markets are nearly all down this year, and several are down more than 10 percent. And many big emerging markets are struggling. China is down 1 percent, Russia 7 percent and Brazil 14 percent.
The backdrop is a darkening economic picture. China's economy is slowing, consumer confidence in the U.S. has sunk for four straight months, and a report next Friday is expected to show a fourth straight month of weak job growth.
As if that weren't bad enough, U.S. companies, from retailers to consumer goods makers to technology firms, are talking down investor expectations for how much they'll earn over the next several months, and that is sinking their stocks.
In mid-June, defense contractor AAR dropped 11 percent after cutting its outlook. Then Philip Morris fell 3 percent after it trimmed earnings estimates. Ryder System, a truck leasing company, reined in guidance last week and fell 13 percent.
Then there's the sorry case of Bed Bath & Beyond, which had been an investor favorite. It lowered earnings estimates June 21 and disclosed it had to give out more coupons to get people to shop. The stock plummeted 17 percent, erasing in hours most of what it gained over several months.
Tally them up, and for every company raising its expected earnings, nearly four are lowering them, according to Thomson Reuters, a financial information company. Projections haven't been that negative in more than a decade.
"We began the year thinking we'd achieved escape velocity," says Barry Knapp, chief U.S. equity strategist at Barclays Capital. "But the second quarter data has deteriorated."
Well, not all of it. The price of gasoline has dropped to a five-month low, which means Americans have more money to spend elsewhere and boost the economy. And the housing market may finally be recovering.
Prices of homes in most major cities rose in April, the latest month for which data are available, and the trend may continue. People have been signing contracts to buy existing homes at the fastest pace in two years, encouraged by low mortgage rates. The average rate on a 30-year fixed mortgage has fallen to 3.66 percent, the lowest on record.
James Paulsen, chief investment strategist at Wells Capital Management, says falling gas prices and mortgage rates have kick-started economic growth in the second halves of the previous two years, and he thinks they will this time, too.
He thinks the S&P 500 could end 2012 at 1,500, up 19 percent for the year. It closed Friday at 1,362.
If the worst of Europe's debt crisis is indeed over, Paulsen's target doesn't seem so bullish. But stocks have rallied on hopes of a permanent fix before, only to be dashed on news of rising Italian borrowing costs, scary Greek elections and teetering Spanish banks. And you can't rule out the occasional unhappy surprise at home, either.
On May 10, for instance, JPMorgan Chase announced that it had lost at least $2 billion on a complex derivatives bet. A little more than a week later, Facebook's debut on the public markets was marred by technical glitches, a delayed open and a sinking stock price.
"You can't build wealth without volatility," says Doug Cote, chief market strategist for ING Investment Management, who says he's been buying stocks. He calls dips in the prices lately "an extraordinary opportunity."
What's got the bulls excited is that stocks look cheap relative to their earnings, at least by some calculations.
The gauge used is called a price-earnings ratio, which you get by dividing a company's stock price by what Wall Street analysts expect the company to earn per share over the next 12 months. Do that for all 500 companies in the S&P index, and you get 12, according to FactSet, a research firm. That is lower than the 10-year average of 14.6, meaning stocks may be cheap and you should buy.
Or to paraphrase Warren Buffett, you should get greedy when investors are fearful.
The problem is, P/E ratios are just a rough measure of the stock value, and the math can be misleading. Some analysts like to compare the current S&P 500 P/E ratio with the average going back further, say 35 years. Over that period, stocks have traded at 12.9 times expected earnings, according to David Kostin, a strategist at Goldman Sachs, suggesting stocks now are not so cheap after all.
Plus, Wall Street estimates for earnings could be too high. For the October-December period, for instance, analysts think earnings will increase by more than 14.4 percent. The average quarterly increase the past 25 years is 8 percent. And the analysts have been cutting estimates recently.
Kostin thinks they'll have to cut a lot more. He says investors expecting an earnings rebound this year will be disappointed. He thinks the S&P 500 might fall 8 percent from here.