The tone of the equity market has certainly changed, as the S&P 500 Index inches back towards the 1,300 level. There’s anticipation about the sovereign debt issue in Greece as well as the upcoming earnings season of which there’s been virtually no earnings warnings from any brand-name companies.
The current commodity price correction will serve as a boost to the economy and corporations, particularly because of the lower spot price of oil. It’s very arguable that oil around $90.00 a barrel is more stimulative than anything the Federal Reserve can do going forward. In addition, lower agricultural and precious metal prices will help corporate margins over the near term, where there should be a pronounced level of earnings growth. From my perspective, the fundamentals for a stock market advance are improving.
But we still have the sovereign debt issue, which will continue to be a global risk to investor confidence and we’re likely to get mediocre economic data over the next few months. That’s why, with the current fundamentals, I’m leaning towards a solid stock market rally sometime in the fourth quarter. Everything would change if we have further sovereign debt problems.
I still feel that the market advantage this year lies with dividend-paying large-cap companies, which continue to have the most pricing power. In the last half of 2010, large corporations told us that they were beginning to raise their prices without affecting demand. This positive trend should hold again this earnings season. Big companies have been amazingly able to grow their earnings over the last several quarters, despite higher costs for raw materials and slower-than-usual revenue growth. For big companies, the ability to squeeze their expenses has been a tremendous boost to earnings. Now that revenue expectations are going up, the bottom line over the next quarter or two should be excellent.
The investing marketplace has been very unsure of itself over the last couple of months, as both equity and commodity prices corrected. A lot of individual investors remain on the sidelines in the absence of any apparent price trend in stocks. I want to reiterate that the key index to follow in this market is the Dow Transportation Average. In terms of individual stocks, all you need to keep an eye on are the railroads. As a group, railroad shares consolidated and traded in a tight range around their 52-week highs when the broader market went south. As long as this group doesn’t go down, the prospects for the rest of the stock market are dramatically improved.
A lower oil price is a direct bonus to the transportation sector and it’s as good as the lowest of interest rates. This upcoming earnings season, read the earnings reports of the big railroad companies. What these companies say about their businesses will be the best indicator for the rest of the economy.