An Encouraging Spring

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Technical, fundamental and seasonality research suggests that equity markets have a good chance of trading higher into spring. Consider the following:

Fundamental influences

The earnings outlook for major U.S. companies for the first and second quarters of 2011 is surprisingly positive despite significant uncertainties around the world. Consensus earnings per share estimates for the 30 Dow Jones Industrial Average companies show an average gain on a year-over-year basis of 21.82 percent in the first quarter and 14.89 percent in the second quarter. Industrials, Financials, Energy and Material stocks are notable on the list of companies expected to report significant gains in earnings for both quarters. Defensive stocks, represented by Consumer Staples and Health Care, are expected to show single digit percentage growth. Major U.S. companies continue to record significant sales and profit growth from international operations. In addition, currency translation of international sales and earnings into weak U.S. Dollars will help the bottom line. The U.S. Dollar Index has declined 3.6 percent in the first quarter of this year and the trend remains negative.

Seasonal influences

U.S. and Canadian equity markets usually move higher at this time of year. Seasonal influences remain positive into May. Based on data for the past 20 years, seasonal gains for the second quarter typically average 2.5 percent for the S&P 500 Index and 2.9% for the S&P/TSX Composite Index.

Historical averages for the third year of the presidential cycle are even better than seasonal averages. Second quarter gains during pre-election years since 1950 averaged 6.2 percent for the S&P 500 Index and 6.1 percent for the S&P/TSX Composite Index.
Major reasons for strength into April and May are news from annual meetings and releases of first quarter earnings reports. Both events frequently occur around the same timeframe. Chief executive officers love to offer good news to shareholders at annual meetings. Positive guidance for the quarter and the year frequently are given. Traders move stock prices higher in anticipation of good news.

Another reason for strength in U.S. equity markets in April is contributions into 401 K plans. U.S. investors can contribute to their 401K plan until April 15th based on their taxable income in the previous year. Contributions into a 401K plan frequently come from anticipation of tax refunds that start to flow in volume in late April. At least some of these contributions are cycled into equity markets.

Technical Influences

Recent technical action by major U.S. and Canadian equity indices suggests that seasonal strength could extend beyond the end of May this year. Major U.S. equity indices already have recovered from a shallow correction in March. Major indices have again traded above their 20 and 50-day moving averages, both of which have provided reasonable levels of support throughout the bull market run that began last September. A breakout to a new 52-week and recovery high by the S&P 500 Index appears imminent. Short term momentum indicators (Moving Average Convergence Divergence, Relative Strength Index, Stochastics) have recently recovered from oversold levels and now are overbought.
The S&P/TSX Composite Index also has a positive technical profile. The Index already has gained 6.3 percent from its March 15th low at 13,280. Short term momentum indicators have climbed to overbought levels.

What to do? Continue to hold economically sensitive equities and Exchange Traded Funds into spring. Optimal time to take seasonal profits can be determined by using technical indicators.