Where do stocks go from here?

For all the talk of a new all-time high in the U.S. equity markets, the Standard & Poor’s 500 index has so far closed above its previous high from back in 2007 on only two days, March 28 and April 2. It has since pulled back about 1%.

The Dow Jones Industrial Average has done a better job of maintaining its newly acquired high ground, having surpassed its previous record on March 5 and remaining there still, although it, too, has declined about 1% in the last few trading sessions.

Of course, the construction and makeup of these indices is different, most notably the Dow being price-weighted and the S&P being capitalization-weighted. And, it is worth noting that the Dow boasts a dividend yield of 2.45% versus the 2.13% yield of the S&P. But, the overall performance of the two indices is quite similar. Both have rebounded remarkably from the depths of the financial crisis. The Dow is higher by 122% on a price-only basis, while the S&P 500 is higher by 129%. Year-to-date the Dow is up 10.8%, while the S&P 500 is up 8.8%. The point is that, whatever the preferred method of measurement is, U.S. equities markets are now wondering what to do for a second act.

Having weathered the storm of policy uncertainty in Washington to start the year, new concerns have arisen lately regarding the pace of economic activity as the second quarter gets underway. The latest jobs figures were disappointing, as were home sales and the ISM indices. None showed enough weakness to cause alarm, and month-to-month numbers can certainly vary. But there has been just enough softness to cast some doubt.

The same has been true with the news out of Europe. The Cyprus situation has been dealt with for now, but the circumstances of its resolution, including the bail-in of large bank depositors and the once-threatened bail-in of small depositors, as well, has also raised some doubts of how such crises will be dealt with in the future. The latest activity and sentiment numbers have been on the soft side, too. And we are continuously reminded that the world contains unstable and unpredictable regimes.

The recent sabre rattling from North Korea is just the latest reminder. South Korean equities have fallen 4.3% in just the past week as these tensions have escalated, and the currency has weakened. But these moves may have as much, or more, to do with the recent weakness in the Japanese yen than with the bellicosity of the North. Even our own Federal Reserve has gotten into the act of creating uncertainty as evidenced by the recent comments from several officials regarding the potential timing of possible adjustments to the pace of QE3, although Friday’s disappointing employment report may put that speculation to rest for a while.

And now earnings season is upon us. Much of the focus has been on how the bar has been lowered during the quarter, as analyst estimates have been lowered to the point where earnings are expected to come in slightly below last year’s first quarter. Also being cited is the number of negative pre-announcements relative to positive ones. And for good measure, the stronger dollar is being cited as a headwind for companies deriving a significant percentage of their revenue from overseas. All of which, of course, could make it easier for aggregate earnings to exceed consensus expectations. Alcoa began the formal announcement season on Monday, to be followed quickly by earnings from the big banks. Alcoa is down on the year as aluminum prices have suffered, but the banks have performed generally in line with the market, and will provide better insight into the overall strength of the first quarter.

Bond investors have certainly benefitted from the sudden angst in equity markets. The Barclays Aggregate index has rallied enough in April to turn its performance on the year positive, albeit just barely. The star performer has been the long-end of the Treasury market, as the yield on the thirty-year bond has plunged from 3.26% on March 11 to 2.88% currently, a price move of 7.5%. During the same interim, the yield on the ten-year note has fallen from 2.06% to 1.72%.

Although stocks are not expensive, the multiple expansion in U.S. equities that has lifted the trailing price-to-earnings ratio on the S&P 500 from 13.5x last summer to 15.3x currently leaves less of a margin for error should earnings disappoint. And there is always the issue of corporate guidance. There are concerns that the economy could slow in the months ahead as it has in the recent past, although the latest Business Roundtable CEO economic outlook survey anticipates higher sales and capital spending over the next six months, but only moderate hiring. That could be a recipe for outperformance by cyclicals going forward versus defensives, especially consumer groups. Even so, don’t count out the dividend paying sectors just yet. It seems clear by the list of sectors that have led the way recently that equity investors remain skeptical of the strength of the recovery and unconvinced that bonds should be sold.

Disclosures
The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.

The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.

The Dow Jones Industrial Average (DJIA) is an index containing stocks of 30 Large-Cap corporations in the United States. The index is owned and maintained by Dow Jones & Company.

The Barclays Capital U.S. Aggregate Bond Index is an unmanaged index composed of securities from the Barclays Capital Government/Corporate Bond Index, Mortgage-Backed Securities Index and the Asset-Backed Securities Index. Total return comprises price appreciation/depreciation and income as a percentage of the original investment. Indices are rebalanced monthly by market capitalization.

It is not possible to invest directly in an index.

Investment products are not federally or FDIC-insured, are not deposits or obligations of, or guaranteed by any financial institution and involve investment risks including possible loss of principal and fluctuation in value.

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