Markets are Working Through the Froth

by Bryan Perry | March 26, 2014 11:26 am

Markets are Working Through the Froth

There’s a wave of fresh initial public offerings coming to market, with almost 100 new listings taking place from the beginning of March through the third week of April. This is just an amazing amount of capital to be raised in the span of less than two months. It’s no wonder to me why the air came out of many of the leading Nasdaq names these past two weeks. Stocks with high price/earnings (P/E) ratios that led through all of 2013 and the first two months of 2014 are being sold off aggressively as fund managers opt for playing the IPO market.

Is this rational? Sure, if you are a powerful hedge fund and can get stock from syndications that allocate IPOs to their best clients. Most retail investors don’t stand a chance to acquire a single share of any hot deal, but when stocks are priced at $15-$18 and open at $25, you can see why big money wants in on the action when they have all the influence to demand participation.

In the meantime, the ruble is getting bid higher while Russia is amassing more military presence along Ukraine’s borders amidst being tossed out of the G-8 with economic sanctions kicking in. China’s factory output contracted for a third straight month, but not to worry: the government is touting more fiscal stimulus. And Europe’s latest round of economic indicators has European Central Bank President Mario Draghi stating that no further easing of monetary policy is necessary.

So we’re back into the realm of most news, good or bad, is taken as the glass being half full. The market remains in a trading range and will continue to do so until the wave of IPOs runs its course and the rotation into more blue chip stocks has also worked its way through the system. Think of it as professionals wanting to stay fully invested, but in stocks with more attractive valuations that sport some yield.

Trading Landscape

Let’s take a look at the one-year chart for the S&P 500 below. Here we are closing out the first quarter of 2014, and the S&P is up less than 1.00% year-to-date. Thanks goodness for covered-call strategies.

There are times when the market simply needs to take time for profits and earnings to catch up with where the market multiple is — and when the S&P is trading at 16x earnings, most market strategists will argue that this is a level of fair value, and in order to justify trading at 18x-19x, the economy needs to be generating GDP growth of 3.5%-4.0%. You would be hard-pressed to find an economist willing to put their name on a 3.5%-4.0% growth forecast for 2014.

perry Markets are Working Through the Froth[1]

I believe that 2014 will be a good year for the S&P performance, but will be very back-end loaded. The data crossing the tape have been marred by winter weather and thus are hard to decipher in the true essence of measuring real trends. Most traders and investors expect the data to markedly improve when reports come out in April and May. Until then, the market will remain range-bound.

Future Outlook

The rotation out of high beta into lower beta is the dominant theme for the week amid the rash of IPOs, which we are only about a third of the way through from seeing that parade wind down. Too much supply at one time is a major headwind for the market in general, but that just falls on deaf ears when investment-banking fees are at stake.

Endnotes:
  1. [Image]: http://cashmachinetrader.investorplace.com/images/2014/cwtr_03252014_spx.png

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