Bulls Corralled as April Losses History Seen Jolting Rally
Even bulls are taking steps to protect profits after gains in U.S. stocks added $10 trillion to equity values, convinced the first decline in earnings since 2009 will spur losses in the historically weak second quarter.
Russ Koesterich of BlackRock Inc. and Valentijn Van Nieuwenhuijzen at ING Investment Management, who bought equities in 2012, say risks are rising during a period in which stocks have lost an average 5.2 percent since 2010, data compiled by Bloomberg show. Concern the U.S. economy isn’t expanding fast enough prompted Koesterich to sell smaller companies. Van Nieuwenhuijzen is holding off on new share purchases.
With the U.S. earnings season beginning today, forecasts for a profit contraction, sluggish economic growth and the market’s history of weakening at this time of year are spurring pessimism. Investors managing more than $5 trillion say they’re looking for ways to limit losses after the Standard & Poor’s 500 Index reached a record. That got harder in the first quarter, when rallies in drugmakers and utilities pushed valuations for so-called defensive industries to the highest since 2008.
“You have an increased risk of a correction now,” Koesterich, the chief investment strategist at New York-based BlackRock, the world’s largest money manager with $3.8 trillion in assets, said in an April 4 phone interview. “The parts of the market that have done the best, the defensives, have gotten very expensive,” he said. “This is a very different rally than what people are used to.”
The S&P 500 fell 1 percent to 1,553.28 last week, the biggest drop of 2013, after manufacturing expanded less than forecast and American employers added 88,000 jobs in March, trailing every estimate in a survey of 71 economists by Bloomberg. The decrease trimmed the rally since March 2009 to 130 percent. The S&P 500 rallied 0.6 percent to 1,563.07 today.
Alcoa Inc. (AA), the first member of the Dow Jones Industrial Average to publish results, reported first-quarter earnings after the close of regular trading that exceeded analysts’ estimates as demand from U.S. automakers increased. Income at S&P 500 companies dropped 1.8 percent in the first quarter, according to more than 11,000 analyst estimates compiled by Bloomberg.
A 10 percent rally in the first quarter pushed the S&P 500 to a record as reports on housing, hiring and consumer confidence showed the Federal Reserve’s near-zero interest rates and bond purchases were helping the economy expand.
“The first quarter took most investors by surprise on the strength and breadth of the equities market,” Jim Russell, the senior equity strategist at U.S. Bank Wealth Management, which manages about $110 billion, said in an April 1 phone interview. Russell, who said pensions and other funds owned too few shares in November, says he’s selling U.S. equities now and buying bonds. “We expect a pullback before too much longer.”
While American stocks have been in a bull market for four years, defined as an advance unbroken by a decline of 20 percent of more, stocks have frequently retreated. The rally has lasted for 49 months and 16 of them have generated losses.
Shares in the benchmark gauge for American equities slipped 3.3 percent from April to June last year, 0.4 percent in 2011 and 12 percent in 2010, three of the five quarterly losses since equities bottomed in March 2009. Industries with earnings least reliant on expanding gross domestic product generated the best returns each time as technology companies and banks fell.
Investors have fewer choices now after defensive industries, normally what fund managers buy when they are concerned about growth, are trading at a 26 percent valuation premium to the rest of the market. Johnson & Johnson (INDU), the largest seller of health-care products, has rallied 17 percent this year, the third-best gain in the Dow Jones Industrial Average. Alcoa has the second-worst decrease, falling 5.1 percent.
“We’re being very cautious,” Chad Morganlander, a Florham Park, New Jersey-based fund manager at Stifel Nicolaus & Co., said in an April 5 Bloomberg Television interview. His firm oversees about $130 billion of assets. “You’re not seeing the self-sustaining lift that we need to have the market go from 1,550 to 1,750.”
Morganlander, who predicted in December that stocks would increase this year, said he’s raised the level of cash in his funds to 18 percent and is buying bonds.
The U.S. economy will expand at a 1.9 percent rate this year, down from 2.2 percent in 2012, according to the median estimate of 83 economists in a survey by Bloomberg. The forecast for a 1.8 percent earnings contraction in the three months ended in March compares with a prediction for a 1.2 percent gain at the start of the year.
Higher price-earnings ratios for defensive stocks are no reason for the rally to fizzle, according to John Stoltzfus, chief equity strategist at Oppenheimer & Co. Rather, they may reflect individuals returning to the equity market for the first time since 2007 who want to keep their investments conservative.
“If you’re coming back to the market, if you’re layering in and building a portfolio, you start to come in with consumer staples, health care,” he said in an April 3 interview on Bloomberg Television’s “Surveillance” with Tom Keene, Sara Eisen and Nela Richardson. “You have a real improvement in fundamentals, and that’s driving stocks higher.” He predicts the S&P 500 will climb to 1,585 by the end of the year.
Valuations for defensive shares are higher than any time since the bull market began. Makers of consumer staples in the S&P 500 trade at 18.1 times annual profit after gaining 14 percent in 2013, led by Avon Products Inc., which has a multiple of 31.
CenterPoint Energy Inc. led utilities stocks to a 13 percent rally, pushing the group’s multiple to 17, while health- care shares such as Celgene Corp. (CELG) and Boston Scientific Corp. gained 16 percent to reach the industry’s highest price relative to income since February 2008.
The valuations signal danger after investors pulled more than $400 billion from U.S. stock mutual funds between 2009 and 2012, said Jonathan Golub, UBS AG’s chief U.S. equity strategist. While about $18.4 billion was sent to those funds in January, the deposits shrunk to $1.1 billion for February and March, according to the Investment Company Institute.
“When you have the market being led by defensives, it’s not a positive sign for a continued rally,” he said in an April 3 phone interview. “The market’s gotten ahead of itself.”
Golub predicts the S&P 500 will fall 8.3 percent to 1,425 by the end of the year. His forecast is below the 1,583 average of 17 Wall Street firms tracked by Bloomberg. At this time last year, he was calling for a 3.9 percent increase in the gauge, making him the most bullish strategist.
Stocks fell 9.9 percent from April 2 through June 1 last year, before the S&P 500 surged to a record last month. In 2011, the index slumped 19.4 percent, its biggest decline of the bull market, then recovered to end the year within a point of where it started. The 2010 drop started April 23, with the index declining 16 percent through July.
This year has been “strikingly similar” to the last three years and investors are bracing for losses, according to Brian Belski, the New York-based chief investment strategist at BMO Capital Markets.
“While strong gains at the open of 2013 have helped most U.S. indices reach historical heights, the rally to date has been met with more skepticism than acceptance,” Belski said in a March 28 report. “The stage is likely set for at least a respite to the market’s ascension.”
He projects the index will end 2013 higher as earnings continue to expand. BMO’s 1,575 projection would represent a 1.4 percent advance from last week and a 10 percent rally for the year, according to data compiled by Bloomberg. Belski held his 2012 bullish call through the April-to-June decline last year. He said in October that corporate fundamentals were in “excellent shape” and in December that multiple expansion would lead stocks higher.
The rally has left the S&P 500 trading at 15.3 times reported earnings, higher than it was in April the last two years, Bloomberg data show.
“Now’s the time to wait and see,” said David Joy, the Boston-based chief market strategist at Ameriprise Financial Inc., which oversees about $681 billion, said in an April 4 phone interview. Joy predicted gains for equities in December as housing and manufacturing improved. “There’s no question the cyclicals are cheaper. The question is, when do they take over the leadership?” he said. “I wouldn’t be terribly aggressive.”
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