Events Drive Sentiment


In the news vacuum between earnings seasons, investor sentiment often swings with the macroeconomic themes of the day. Until the next wave of quarterly reports, no event looms larger than the Federal Reserve's decision on interest rates, to come out of its meeting on Dec. 15 and 16. But the Fed is not the only player in this drama, and below we look at three other themes likely to weigh on investor sentiment.

The U.S. consumer

Consumer spending figures to be the primary driver of U.S. growth over the next five quarters, says Blue Chip Economic Indicators. Consumers currently benefit from higher wages, healthy confidence, and looser lending standards.

The holiday shopping season got off to a solid start, after a sluggish September and October. Yet retail stocks have fallen out of favor with investors, while other consumer-discretionary industries — automobiles, housing, and restaurants — are doing fairly well. Unseasonably warm weather has hurt apparel retailers, stocked with sweaters and winter coats. Other retailers suffer from a shift in spending patterns, as rising rents and health costs, student debt, and high-tech gadgets take a greater share of consumers' wallets.


Concerns about slowing growth in China presaged a sell-off for U.S. stocks in August. Little has changed to improve sentiment since then. China's economy grew 6.9% in the September quarter, its slowest rate since 2009. The results dampen China's prospects for reaching the government's official target of 7% growth this year.

In November, China's manufacturing activity contracted for the fourth straight month, slipping to its lowest level since August 2012. Weak demand has caused manufacturers to idle factories and cut prices. Yet nonmanufacturing activity expanded last month; consumer services are becoming more important to China's growth.

The earnings recession

In recent weeks the popular press has fretted that stocks are due to turn lower because of the so-called earnings recession. In the third quarter, per-share profits for the S&P 500 Index slipped 1% on a capitalization-weighted basis, with 99% of stocks having reported, its first decline since the September 2009 quarter. The S&P 500 weights its components by stock-market value, meaning that large companies have a greater impact on the index than smaller firms. Yet S&P 500 stocks averaged 3% profit growth last quarter, as shown below.

Nevertheless, operating growth is low relative to historical norms — and it's not looking much brighter for the December quarter, with the index's per-share profits projected to decline 3%.

Fortunately, stock valuations and shareholder expectations appear reasonable. The average stock in the S&P 500 trades at 21 times trailing earnings, in line with its 20-year average. Valuations look elevated based on average price/sales ratio, but the S&P 500 last traded below historical norms for price/sales in February 2013. Moreover, sentiment among newsletter editors and investors appears restrained.

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