Federal Reserve chairman Ben Bernanke offered encouraging comments on the U.S. economy on Monday. U.S. equity indices responded by tacking on strong advances. The Dow Jones industrial average gained 1.23 per cent, the S&P 500 Index improved 1.39 per cent and the Nasdaq composite index advanced 1.78 per cent to reach an 11-year high. Traders responded primarily to one word made by Bernanke: accommodative. He noted that the Federal Reserve's monetary policy will remain "accommodative" until fragile economic growth in the U.S. is sustained. Traders interpreted "accommodative" to mean that a third quantitative easing programme to stimulate the U.S. economy remains a possibility.
Strength in U.S. equity indices comes at an interesting time prior to a series of events during the next few weeks that could cause U.S. equity indices to pause recent uptrends:
• Economic news for the month of March generally will not help equity markets. March economic reports to be reported in April will have a difficult time showing gains on a month-over-month basis over exceptionally strong February data.
• Consensus estimates show that total first-quarter earnings by S&P 500 companies are expected to show no increase year-over-year. That includes a 52 per cent increase by Apple, the company with the biggest influence on the S&P 500 Index. A major reason for the slowdown on a year-over-year basis is currency translation. The U.S. dollar index averaged 80 in the first quarter of 2012 versus 78 in the first quarter of 2011. Approximately half of the earnings from S&P 500 companies comes from outside of the U.S. Earnings from outside of the U.S. must increase 2.6 per cent in 2012 to match earnings last year.
• First-quarter earnings reports by S&P 500 companies are likely to be accompanied with mixed to negative guidance for the second quarter. Once again, currency translation will have an impact. Average for the U.S. dollar index in the second quarter last year was 75 implying that earnings outside of the U.S. must increase 6.7 per cent in 2012 to match earnings last year if the U.S. dollar index remains near 80.
• Short and intermediate technical indicators show that U.S. equity indices currently are overbought. Investors are willing to take profits following gains since lows set on October 4th. The S&P 500 Index is up 31.8 per cent, the Dow Jones Industrial Average gained 27.3 per cent and the Nasdaq composite index has advanced 35.8 per cent.
• Seasonal influences during a U.S. Presidential election year historically turn negative in the first week in April. Prior to the beginning of April, at least one of the major parties has multiple potential candidates. The peak into early April tends to coincide with equity market perception that final candidates for the Presidency have been chosen. This year, Obama is the Democrat Party selection and Romney is the most likely Republican Party selection. Political campaigns quickly change focus from fighting each other to fighting the incumbent (the so called EtchASketch effect infamously mentioned last week by Romney's campaign organizer). Watch for the change in focus to occur just after Easter. Negative political rhetoric ramps up from both sides. Consumer and investor confidence declines, economic growth statistics stall and equity markets move lower. On average during U.S. Presidential election years since 1930, the Dow Jones industrial average has dropped 3.5 per cent from the first week in April to the end of May.
What to do? Ben Bernanke gave investors a bonus on Monday. Take it while you can. Investors with a time horizon of three months or less will want to protect themselves by taking profits before Easter in broadly based U.S. equity index ETFs including S&P 500 SPDRs , DJIA SPDRs and PowerShares QQQ Trust . Investors with a longer time horizon can hold through the period of weakness. U.S. equity markets have a history of moving higher from the end of May to the end of the year during a U.S. Presidential election year.
Don Vialoux is the author of free daily reports on equity markets, sectors, commodities and Exchange Traded Funds. Daily reports are available at www.timingthemarket.ca/. He is also a research analyst for Horizons Investment Management Inc. All of the views expressed herein are his personal views although they may be reflected in positions or transactions in the various client portfolios managed by Horizons Investment Management.