At the start of 2012, investors were assessing whether it was wiser to focus on the deep value that many stocks offered, or the incipient signs of a global economic slowdown that would cap any upside for stocks. They focused on the former in the first quarter, giving stocks a solid boost. But it was the economic headwinds that dominated investor sentiment during the second quarter.
For the rest of the year, you can expect more of the same.
The market is likely to focus on still-cheap valuations whenever the global news flow quiets down. And investors will likely shun stocks when the economic seas get rough.
Still, it's been an uneventful six months -- at least in terms of unexpected events. Europe remains a mess (what's new), U.S. corporate profits remain quite robust (no surprise there) and the economy is still in growth mode (though hardly robust).
Perhaps the next six months will bring a change and the market will respond to new catalysts.
Here are five events that could shape the market's direction well into 2013...
1. Iran blinks and oil hits new lows
The Iranian government is in saber-rattling mode again, test-firing a missile to snub any perception of weakness when it comes to negotiating nuclear restrictions. I think it's a bluff, so the recent move back up toward $90 crude oil is a head-fake.
Recent reports about Iran imply that economic sanctions have really taken a toll. Inflation is surging and domestic economic activity is shrinking. Another round of sanctions, this time focused on a global boycott of Iranian oil that took root on July 1, promises to deepen the economic distress. That's why Iranian leaders will have to shift course -- sooner rather than later -- and agree to severe restrictions on their nuclear development program.
If and when that happens, then look for oil prices to resume their downward slide. Demand for oil remains weak, and here in the United States rising production is starting to take a meaningful bite out of oil imports. This could set the stage for a drop in West Texas Intermediate Crude to $70 or even $60.
2. The sharp airline rally
Along with makers of pick-up trucks, transportation firms and operators of cruise ships, no industry would be more pleased to seeing falling crude oil prices like airline carriers. Jet fuel is their single-biggest expense, and by some estimates, a $10 drop in crude oil pumps up industry profits by more than $1 billion. The Dow Jones U.S. Airlines, which has fallen from 120 in 2007 to a recent 70, looks poised to be one of the top performing indexes of the next six months.
It's not only about falling fuel prices. Companies that operate leisure parks such as Disney (NYSE: DIS), Six Flags (NYSE: SIX) and Cedar Fun (NYSE: FUN) have traded up to 52-week highs in recent sessions as vacation spending spikes higher.
The Obama administration recently streamlined travel regulations and visa requirements for foreign visitors, which has set the stage for a banner year for tourism. Analysts at McKinsey & Co. note that if foreign travel to the United States rebounded to pre-9/11 levels, when it became much harder to get a visa, then the U.S. economy would receive a $214 billion annual boost. Airlines will play a key role in bringing those tourists over.
3. The U.S. economy slumps in the summer but surges in the fall
The U.S. economy is clearly slowing as the weight of depressed trading partners starts to drag us down. U.S. manufacturing activity dropped in June to its slowest pace in three years. Other economic surveys such as the CFNAI are also flashing concern. As a result, second-half outlooks from many major companies could be downbeat enough to bring stocks to their lowest levels of the year.
Yet there are seeds of hope. Recent events in Europe will likely help to avert any major crisis in the near-term, and the Chinese government is now stepping up its own stimulus efforts. As a result, many key players in the European and Asian economies that had been holding back on orders for fear that economic events will spiral lower will likely shift gears. The pent-up demand could yield to a snapback by the fourth quarter, which will likely boost the U.S. economy later in 2012 and into 2013.
4. The natural gas rally no one sees coming
Although the U.S. Northeast was pummeled by Hurricane Irene last summer, the rest of the country has dodged a bullet in recent years. It's been several years since a major hurricane damaged the drilling rigs in the Gulf of Mexico. But water temperatures in the Atlantic basin remain elevated, which helps explain why we had four named storms in June -- the highest number on record.
If the trend persists, then there's a decent chance that one of this summer's big storms is perfectly situated to wreak havoc on the Gulf of Mexico's energy complex. The last time that happened, in 2007, natural gas prices surged.
This time around, it's imprudent to expect a huge jump in natural gas prices because onshore production is much more robust these days. Still, natural gas is already on the rise -- jumping from under $1.95 per thousand cubic feet (MCF) in late April to a recent $2.80. An active hurricane season could easily push that figure toward $3.50 or even $4. This would bring a huge sigh of a relief for gas drillers that were buckling down for a long-term phase of $2 natural gas.
5. Massive banking
One of the unintended consequences of the pending Dodd-Frank banking legislation is that it will make it very difficult for local banking franchises (those with less than 100 branches) to earn sufficient profits while complying with the costly regulations. As a result, look for leading regional banks such as U.S. Bancorp (NYSE: USB), Huntington Bankshares (Nasdaq: HBAN), Regions Financial (NYSE: RF) and others to go on a buying spree. Analysts will see these deals as immediately accretive and rising profits should set the stage for a solid rally in these regional banks late this year and into 2013.
Just as is the case with mega-banks, these regional banks are currently quite inexpensive, typically trading for around 10 times earnings and right around book value. An improvement in the housing sector, a growing sense that the U.S. economy will remain in growth mode in 2013 and the aforementioned merger and acquisition benefits should all provide tailwinds to this sector.
Risks to Consider: There's certainly the possibility that a different exogenous event will have the greatest effect on the market in the second half of the year.
Action to Take --> On balance, we look poised for more "upside" surprises than negative shocks. But we have to get past a tough summer with tepid-sounding economic reports and cautious management commentary when companies are discussing near-term prospects.