Exxon Mobil and Other Large-Cap Leaders Will Continue to Motivate the Stock Market
Companies / Corporate Earnings Mar 01, 2011 - 08:50 AMBy: Money_Morning
Jon D. Markman writes:
The trends that are established at the start of the year often persist through yearend.
That makes now - the first day of March - a good time to look at the unique trends that have characterized the first few months of 2011 and hazard a guess as to whether or not this bull market will keep running.
The biggest anomaly that I see so far is the absolutely rockin' pace of the Dow Jones Industrial Average. These big-cap stocks are blowing down the joint, and showing no signs of stopping.
Normally, in a strong year, you will see the emerging market stocks or the Nasdaq Composite Index in the lead. But that hasn't been the case in 2011. It's the old guard of the Dow Jones Industrials in the lead this time around.
So why is this happening, what does it mean, and how much longer will it last?
M-V-P
The answer to the first question is most likely embedded in a phenomenon we have been talking about for months: The sudden reversal higher of large-cap energy stocks -
particularly Exxon Mobil Corp.(NYSE: XOM).
I have said that XOM is so big that it can put the rest of the market on its back and carry it higher. That is pretty much what's happening.
Just like the Los Angeles Lakers are Kobe Bryant's team, the Dow is now Exxon's team --and the blue-chip energy company is looking like the market's most valuable player.
Energy makes up 13% of the big indexes, so when Exxon and its peers are rising in value they present a virtually unstoppable force.
Oil prices breached $100 a barrel for the first time in two years last week.
The higher price of oil could be a major headwind for developed market economies in the second half of the year. But the value of oil company stocks will surge because current earnings estimates are all predicated on the idea that the global benchmark price will be around $80-$85 a barrel this year. If it's more like $90-$105 a barrel, then you will see energy companies' earnings estimates start to explode higher along with their stock prices.
Now it may seem like crude oil itself is the way to exploit a move like this - but it's not. Energy company equities are the way to go, and here is why.
Oil company prices and spot crude prices are highly correlated, but energy stocks outperform energy indexes on a total return basis for a very simple reason: Yield.
Energy stocks like Exxon produce dividends, while the "carry" on commodities is negative. For the commodity futures and the exchange-traded funds (ETFs) that track them, the negative yield stems from the cost of rolling futures contracts. For physical holders, it's the cost of storage and insurance.
Of course, energy companies aren't all that's driving the Dow.
Other DJIA companies that are playing well include The Walt Disney Co. (NYSE: DIS), Caterpillar Inc. (NYSE: CAT), International Business Machines Corp. (NYSE: IBM), 3M Co. (NYSE: MMM), United Technologies Corp. (NYSE: UTX) and Verizon Communications Inc.(NYSE: VZ).
Pay close attention to Caterpillar, Disney, United Technologies and IBM. They represent four distinct facets of the economy: construction, media, industry and technology. And Exxon adds energy. Only healthcare stocks like Merck & Co. (NYSE: MRK) and struggling techs Microsoft Corp. (Nasdaq: MSFT) and Cisco Systems Inc. (Nasdaq: CSCO) are not pulling their weight.
The bears can complain all they want about how this rally has been bought and paid for with debt and funny money from the U.S. Federal Reserve. But we need to at least acknowledge that it seems that we have gotten what we paid for: A rip-roaring bull market for the most important industrial giants in the world.
There's an argument to be made that it won't last longer than it takes U.S. Federal Reserve Chairman Ben S. Bernanke to end QE2. But in my view - which is based on historical precedent, intuition and experience - it's hard to bet against this bull run.
It takes so much energy to get these giants off their tails and moving higher in sync that it would require a major elbow to the face to knock the earnings momentum and Price/Earnings (P/E) multiple expansion that this move represents off its trajectory.
Dissecting the Data
A quick look at some market data corroborates our recovery story.
Jason Goepfert over at Sundial Capital reports the following set-up:The Standard & Poor's 500 Index recently hit a new 52-week high, then experienced three straight hard down days. But each one was a lesser loss than the day before.
When this has occurred in the past, 90% of the time the benchmark index has rebounded back to its prior highs within two weeks.
It took a median of eight trading days for the S&P 500 to close at a new 52-week high, with eight of the ten instances taking less than 13 days. The maximum loss before hitting a new high averaged -1.1%, with only two of them dropping more than -2% at any point before recovering.
There was one occurrence in October 1997 that took two months and a -10% interim loss before closing at a new high. But other than that, it's rare that you see more selling pressure before bulls gave it another shot.
There are no guarantees that the current setback will recover in exactly the same manner, but the point is that investors tend to react to a given set of stimuli the same way over and over. This data says that when the market is trending up strongly and then gets crunched for three days, it tends to recover quickly.
This won't always be the case, but with a new month beginning today (Tuesday) - an event that has been very bullish over the last two years - and the very positive headlines that are likely to follow February's employment gains, it's a decent bet to work out.
Bulling Through Hurdles
Of course, none of this is to say the ride higher won't be bumpy. The Chicago Board Options Exchange (CBOE) Volatility Index jumped 27.5% on Feb. 22 for its largest gain since May 20, 2010.
European debt woes were in the headlines that day in May 2010, and we now know that those fears ultimately went nowhere: Most European markets made their lows for the cycle in the next one to five days, and were soon off on sharp advances. One of the best examples is iShares MSCI Switzerland Index(NYSE: EWL), which made its low the next day and has since rallied 40%.
The point is that sharp spikes in volatility that engage all sectors, regions, market caps and style groups tend to be terminal events, not initiation events. In other words, they tend to allow investors to get all their selling done at once, and then everyone usually starts to feel better.
Indeed, the U.S. and European markets have risen briskly for the past two years - in spite of any obstacles the market gods have thrown in their way.
The most recent event of this nature occurred a month ago when Egyptian strongman Hosni Mubarak defied expectations by promising to stay in power forever, or at least through summer. There were fears that radicals would take over the Suez Canal and prevent crude oil from reaching Europe, and worries that Islamists would start a new anti-American government on the spot.
Bears loved that story and ran it up the flagpole on the last Friday of January, causing the Dow to sink around 160 points. But a few days later, all was forgiven and the rally resumed.
There were certainly reasons to suspect bears might finally get their time in the sun last week. Not only were protests in Libya causing a sudden re-pricing of global risk, but higher oil prices were believed to threaten the nascent U.S. economic recovery - higher gasoline prices would amount to around a $50 billion tax - and it was reported that housing prices fell for a sixth straight month in December.
Yet at the end of the day, what really changed?
Libya is the largest producer of oil in Northern Africa, but that's not saying much. The Organization of Petroleum Exporting Countries (OPEC) - which controls nearly half of the global oil supply - can increase production to make up for the temporary loss of Libyan oil. And in the United States, supply is not even close to a being problem: Oil storage tanks in the Midwest and Southwest are actually overflowing, which is what had kept West Texas Intermediate crude prices so low relative to the Brent price paid in Europe.
[Editor's Note: Money Morning Contributing Writer Jon D. Markman has a unique view of both the world economy and the global financial markets. With uncertainty the watchword and volatility the norm in today's markets, low-risk/high-profit investments will be tougher than ever to find.
It will take a seasoned guide to uncover those opportunities.
Markman is that guide.
In the face of what's been the toughest market for investors since the Great Depression, it's time to sweep away the uncertainty and eradicate the worry. That's why investors subscribe to Markman's Strategic Advantage newsletter every week: He can see opportunity when other investors are blinded by worry.
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