After a brief pullback to retest support levels, it appears that bulls may be preparing to take the market higher. Although retail investors are still hesitant, risk-taking among institutions is apparent. Cheap cash from abundant global liquidity is hungry for higher returns. Margin debt is high. Credit spreads are low. Subprime loans are back in vogue. Small caps and the banking sector in particular look ready to resume a leadership role.
In this weekly update, I give my view of the current market environment, offer a technical analysis of the S&P 500 chart, review our weekly fundamentals-based SectorCast rankings of the ten U.S. business sectors, and then offer up some actionable trading ideas, including a sector rotation strategy using ETFs and an enhanced version using top-ranked stocks from the top-ranked sectors.
Market overview:
After last week’s strong jobs report (coming in 25% above expectations), Treasury yields spiked, the dollar strengthened, and dividend stocks took a hit while growth stocks held up, particularly the NASDAQ, mid caps, and small caps. Market commentators of course have expressed a wide range of views ranging from cautious optimism to outright collapse. For example, Goldman Sachs’s chief U.S. equity strategist David Kostin just announced a prediction that the S&P 500 will finish the year around current levels as the market simply treads water and relies upon dividends for further returns.
Some of the dominant concerns include the fact that total margin debt is at record levels, hitting $507 billion in mid-April, and while the major indexes have been hitting record highs, breadth is narrow (NYSE Composite has not challenged its high), GDP growth has shrunk, unit labor costs have surged, and corporate profits have struggled.
Of course, the strong dollar has been blamed as a prime culprit for hindering profits. However, the U.S. economy overall has enjoyed a net benefit from the strong dollar, with low oil and gasoline prices, affordable imports and overseas travel, and foreign investors flocking to the safety, yield, and bullish trend of the dollar. Nevertheless, although companies appear to be doing some hiring, they continue to be reluctant to make much in the way of new capital investment in PP&E.
As a result, 95% of profits at S&P 500 stocks last year were used for stock buybacks or dividends. In April, $133 billion of new stock buyback programs were announced, the highest level ever for a single month. In fact, buybacks have been the biggest source of accumulation. At the current rate, the overall market is on track to hit over $1 trillion in buybacks.
We keep hearing that it has been three years since the market pulled back at least 10%, and although investors are worried that any of a variety of potential triggers could start a massive correction, stocks continue to hold up pretty well — even though the former resistance-turned-support thresholds of Dow at 18,000 and S&P 500 at 2100 failed as support. Learned observers insist that we desperately need a 10% correction soon in order to stave off a 20% debacle later. But few traders are willing to let it happen in this low volatility environment. The CBOE Market Volatility Index (VIX), a.k.a. fear gauge, closed Friday at 14.21, and the 15 threshold has held as resistance.
