The S&P’s Negative Outlook on U.S. Debt

S&P's gives the thumbs downApril 18, 2011: In the markets, as in life, there are no guarantees but everyone is entitled to their opinion. Here’s my opinion on the financial markets today.

The Nitty Gritty Details:

Futures were already down several points this morning following an increase in China’s reserve requirements and the market’s ongoing focus on Europe’s debt woes as Greece default concerns intensify.  Stocks then took another leg down after the news broke that S&P revised its outlook for U.S. sovereign debt to negative.  The market appeared to take the China news mostly in stride as further tightening has been expected, although commodities are under some pressure this morning.  The earnings news looks relatively good, although the focus on the U.S. budget situation will drown it out.  European markets are lower in mid-day trading overseas on growing sovereign debt concerns and some spillover from the U.S. sell-off, while Asian markets closed mostly lower by between one half and one percent.  U.S. crude is down more than a dollar to $108, erasing Friday’s gains after the Saudis characterized the market as oversupplied.

Looking back at Friday, stocks managed a modest gain as economic data outweighed earnings.  Stocks edged higher Friday despite earnings-driven declines by a major technology company and a significant bank.  A subdued consumer inflation reading, solid New York manufacturing survey, better-than-expected industrial production data and improved consumer confidence helped push stocks higher despite Chinese inflation concerns and an Irish debt downgrade.  Tech lost about a half percent on the day, while the rest of the S&P sectors managed to advance led by Utilities, Health Care and Energy.  The S&P lost 0.6% last week but is still up over 5% on the year.

The Markets Broken Down:

Around our financial planning firm this morning, we were discussing four issues that we thought would be of particular interest to our readers:

  1. The National Association of Homebuilders Index will be released today. The index, which measures single family home sales as well as expectations for sales over the next 6 months, is expected to be unchanged from last month.  Given that there is still a sizable inventory of unsold homes, construction of new homes remains relatively weak.  Additional housing data will be released tomorrow with housing starts and building permits, followed by existing home sales data on Wednesday.  Each of those numbers is expected to show improvement from the previous month.
  2. The earnings upside is more subdued thus far. With about 10% of S&P companies’ results in the books, companies are beating expectations at a solid rate again, but not by as much as we have seen in previous quarters.  After beating estimates in aggregate by between 5 and 10% over the past seven quarters, S&P 500 earnings are only tracking about 1% ahead of estimates thus far.
  3. On Friday, the Treasury released its Treasury International Capital (TIC) data for the month of February. The report showed that overseas investors purchased $31 billion of Treasury notes and bonds.  China remains the largest foreign holder of Treasury securities at $1.1 trillion, followed by Japan at $890 billion.  While the TIC data is released with a 6-week lag, evidence points to continued strong demand for U.S. debt among foreign investors.
  4. Small-cap stocks now command the widest premium over large caps in at least a generation, based on the ratio of price to earnings. The Russell 2000 Index, comprising about 2,000 stocks with small market capitalization, is within 2% of a record closing high.  Small caps, which typically have a market value of about $2 billion or less, often do better than large-cap stocks in the first stages of a recovery.  The valuation gap has approached this level twice before, in 1983 and 2007.

As always, email me here with your questions or comments.  I love to hear from you and thoroughly enjoy the “intellectual debate” with our clients and friends that these opinions generate.

Greg Powell, CIMA
Wealth Consultant

Note: The opinions voiced in this material are for general information and are not intended to be specific advice. Any indices such as the S & P 500 can’t be invested into directly. Past performance is no assurance of a future result.

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