3 Rising Fears That Could Spark a Stock Sell-Off

There are three rising fears that could spark a stock sell-off. These include consumers running low on fuel, the potential crisis in Italy, and earnings growth. These three issues may creep into the headlines in coming weeks and it is likely they will become problematic in the long-term.

February 27, 2013
The Fiscal Times

With all the buzz in the market about Federal Reserve Chairman Ben Bernanke’s appearance before Congress this week and whether sequestration will kick in on Friday, stock market investors are on tenterhooks. Bernanke may have offered up a defense of the Fed’s bond-buying program on Tuesday, but the continuation of QE3 is far from the only worry that could weigh on investors. The S&P 500 index has already dropped 1.5 percent over the last week, and despite Tuesday’s gains, fears are still mounting that this year’s great start in equities may end not with a whimper but with a bang.

It wouldn’t be unprecedented, and there are plenty of reasons to be anxious about the long-term outlook for stocks. But in some cases, those catalysts aren’t necessarily the same as the ones that have been causing investors to re-evaluate equities. Rather, they are the ones that have the potential to turn what otherwise might be a temporary setback into a lasting market slump.

Consumers Running Low on Fuel: You’re not hallucinating. Gas prices really are higher than they were a year ago at this time. Jeffrey Kleintop, chief market strategist at LPL Financial, calculates that they are 16 cents per gallon higher than they were last February, at a national average retail price of $3.75 a gallon. Moreover, price increases have soared 45 cents since the beginning of 2013, with the bulk of the gains recorded this month. Why does this matter? Well, higher payroll taxes already mean that most Americans are taking home less in the way of disposable income than they were only a few months ago, and that already is showing up in the same-store sales results at Wal-Mart (and ultimately may be reflected in lower profits).

The U.S. economy is dependent on the health of the consumer, which in turn means that the profits at most U.S. corporations hinge on our willingness and ability to open our wallets and spend. If higher gas prices mean that we travel less, then hotel chains and airlines (jet fuel costs will climb, too) will feel the impact. Airlines will take steps to control their own costs to keep profit margins high. Heavy industrial companies that depend on orders for hotel renovations or new aircraft will be hurt. That is, as long as gasoline prices keep rising or even stay at higher-than-average levels. This could just be an earlier-than-usual kickoff to the usual summer driving season, of course, in which case prices will begin to subside by midyear. But to Kleintop, it is one of a series of signs that the stock market is about to peak, as has been the case in each of the last two years.

The Italian Job: The European crisis raises its head again, just when we had managed to shove it to the back of our list of worries. Mario Monti, an economist, stepped in in late 2011 to oversee a “unity” government of technocrats and economic experts, and during his brief tenure as prime minister introduced a raft of austerity measures and reforms with the goal of restoring market confidence in the country’s embattled economy. Monti got Italy off the danger list, at least temporarily, and stepped down in late December after passing a second budget. Alas, the elections just held to select a new government have ended in what appears to be an impasse. Parties at least partly opposed to Monti’s reforms picked up support from disaffected Italians – as did a protest party formed by a comedian, Beppe Grillo. While it may be possible for the Democratic Party to form a government, the country’s Senate appears headed for gridlock, with no party commanding a majority. As for Monti’s technocrats, their winning less than 10 percent of the vote was not encouraging news for those who had hoped that the prime minister’s regime marked the first steps toward greater stability, not a political anomaly. It’s all a reminder that many of Europe’s fundamental challenges remained unresolved, and that the key to fixing the continent’s economic problems lies in the political domain.

Earnings Growth: The fourth-quarter earnings reporting season is almost at an end, and in only about six weeks’ time we’ll all be looking at the earliest of the earnings announcements for the current quarter. While the end of 2012 was a pleasant surprise, with the earnings growth rate higher than expected and a hefty number of better-than-anticipated results, analysts are more gloomy than usual when it comes to the first three months of this year. Any gain in stock prices hinges on the expectation of higher profits, so bearish earnings forecasts are a major sign of worry.

It’s not unusual for analysts to lowball projections as each quarter of the fiscal year draws. What does stand out is the rate at which companies themselves are putting out downbeat guidance, taking advantage of their fourth-quarter earnings conference calls to warn investors not to be overly optimistic about the prospects for earnings growth in 2013. So far, Thomson Reuters calculates that 79 of the companies in the S&P 500 index have published negative guidance, while only 19 of them have issued positive forward-looking statements. That ratio is more bearish than has been seen since 2001, analyst Greg Harrison concludes. So, unless there is an even more dramatic shift in expectations as earnings season kicks off, or companies decide their early conclusions were erroneous and change their minds publicly next month, the odds are that the stock market could have a hard time finding the kind of improved fundamentals that it needs to keep itself on track.

These three issues may creep into the headlines in the coming days and weeks – as Europe’s problems are doing right now – but it is the longer-term likelihood that they will be problematic that marks them out as real perils. Without these clouds hanging over the market, the current level of anxiety about what Bernanke said and will say this week would be less acute, and there would be somewhat less fear that sequestration, or at least a few weeks of it, will completely derail the economic recovery. As things stand, however, what we have is a toxic brew of factors, short and long term in nature, that collectively have investors in a tizzy and are sending volatility levels sharply higher. (The CBOE Volatility Index fell 11 percent Tuesday after spiking 34 percent on Monday.)

You may want to brace yourself for a bumpy ride

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