This 1 Figure Could Keep the Stock Market From Reaching New Highs

The S&P 500 has been practically unstoppable for more than five years, but this one figure could mark the end of the rally.

Apr 19, 2014 at 5:25PM

Following a perfect week for the S&P 500 (SNPINDEX:^GSPC) in which investors saw the index rise four straight days, stock market skeptics and short-sellers are once again left to ponder what might have been.

This has been the modus operandi of the market for much of the past three years, with only minute and short-lived corrections to the downside followed by a march toward new highs. Of course, a number of factors have played into the overall market and broad-based S&P 500's advance.

3 reasons the market has been unstoppable
First and foremost, an extended period of historically low lending rates have allowed businesses to take on debt and expand, boosting hiring and potentially their long-term growth prospects. It's also been a boon for consumers as well as the housing industry, with low mortgage rates driving home sales and low interest rates allowing consumers to refinance their homes and other large loans at attractive rates.

Wall Street Bull Bw


Steady hiring has also led the unemployment rate significantly lower, pushing what was once a 10% unemployment rate during the recession down 33% to its current level of 6.7%. A lower unemployment rate likely means consumers have more disposable income – and since disposable income is such a vital part of GDP growth, it could portend good things for the U.S. economy.

Finally, we've seen the loan portfolio quality of our nation's banks improve drastically. Sure, many are still dealing with the legal ramifications of the housing bubble and loans made during that period, but the overall quality of loans currently sitting on the books of our nation's banks has improved substantially. Long story short, if another recession were to hit the United States, the banking sector should be in good shape to handle it.

One big reason to be skeptical
But, there are a number of concerning factors that a skeptic such as myself has a hard time ignoring. To quickly summarize, as I've pushed these points on a number of prior occasions, a dearth of actual jobs growth in the wake of falling labor force participation, a scaling back of QE3 which can crush interest-sensitive industries, and cost-cutting and buyback-driven EPS growth without top-line growth are all reasons worth questioning the markets' current valuation.

Yet, there's an even bigger reason that investors should question whether or not this rally can continues -- one figure to be exact.

According to research firm FactSet, which offers a bevy of research projections and facts surrounding the S&P 500, first-quarter earnings for S&P 500 companies are expected to decline by 1.3%. This would mark the first year-over-year decline in EPS since the third-quarter of 2012 where EPS dipped by 1%. Furthermore, even though we've only cracked the surface for earnings season, companies that have warned (nine) are outnumbering those that have issued positive EPS guidance (six).

I'll concede that the polar vortex in January and most of February didn't help U.S. businesses and put them behind the eight-ball heading into Q1 reports. But, I'd also contend that hiding behind the weather excuse isn't going to cut it this time. You see, when EPS decreased in Q3 2012 businesses had simply outgrown their means of expansion. Low lending rates fueled debt-driven expansion which we knew at some point would slow down. However, it didn't take long for businesses to adjust just months later and send EPS higher.

The big concern I have is that EPS growth over the past year has been driven by cost-cutting and share buybacks rather than strong top-line growth. As FactSet points out, blended revenue growth is expected to clock in at 2.1% for Q1, below prior forecasts. Yet, if EPS does indeed decrease and revenue rises, then it would mark the first quarter since Q3 2008 (hint, hint, right in the middle of the great recession!) that this occurred.

The proof is in the pudding
As an investor you can essentially pick a sector and run into a veritable wall of worry at the moment.


In the banking sector we have Bank of America (NYSE:BAC) -- a personal holding of mine by the way -- which reported a $0.05 per share loss, $0.10 per share worse than expected, as net revenue declined by 3% from the year-ago period. I've been a holder for two-and-a-half years so I consider myself in at a very attractive price for the long run, but I can't help but be concerned about EPS and revenue both heading lower from the previous year despite an obvious improvement in the U.S. economy. 

Things weren't nearly as dire for warehouse retailer Costco (NASDAQ:COST) which reported a 6% increase in revenue in March, but it still saw EPS dip from $1.24 to $1.05 in its latest quarter as the cost to replenish goods in its stores rose notably. Coupled with a cold winter, Costco's EPS growth this year will be a marginal 3% compared to its current trailing P/E of 25. To add, Costco has now missed Wall Street's EPS forecasts in three straight quarters

It's much of the same story in the metals sector with aluminum giant Alcoa (NYSE:AA). Although results dazzled Wall Street with yet another adjusted earnings beat, total revenue fell 6.5% from the year-ago period as aluminum prices sank 8% year-over-year. The end result was a profit that fell by 31% from Q1 2013. With no clear end in sight as to when aluminum supplies will lessen, or prices improve, Alcoa remains something of a "cross your fingers" type play.

In the technology sector we've got a software behemoth in Adobe Systems (NASDAQ:ADBE), which is in the process of transitioning from a licensing model to razor and blades software platform which will improve customer loyalty, and ultimately cash flow, over the long run. Investors, though, have priced Adobe as if success were a given with shares more than doubling over the past two years despite a 1% decline in revenue growth and a 31% decline in adjusted net income in its latest quarter from the prior year.  

This skeptic is even more skeptical now
The list could go on and on. The point being that share repurchases and cost-cutting should be making a demonstrably positive impact on S&P 500 companies, but it's not. If you recall, 2013 was the second-biggest year for share buybacks in S&P 500 history, so a projected 1.3% decline in EPS for Q1 makes it seem like a number of companies made a very poor choice in repurchasing their own shares.

Source: S&P Dow Jones Indices; all figures in billions of U.S. dollars. 

This forecasted drop also puts in focus the fact that cost-cutting and share buybacks are short-term growth drivers and no substitute for top-line growth and innovation.

Unless I see a definitive return to both top and bottom-line growth in S&P 500 companies, especially following the incredible run the index has had over the past five years, I'm of the opinion that this bull market rally has just about run out of horns to gouge short-sellers with. I could be wrong – I certainly have been on a number of occasions before – but the signs favoring skepticism of this rally are growing.

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Sean Williams owns shares of Bank of America, but has no material interest in any other companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

The Motley Fool owns shares of, and recommends Bank of America and Costco. It also recommends Adobe Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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