Was that really a breakout? With the S&P 500 struggling around the 2,000 level for the past two weeks, Friday’s strong finish might seem like a bullish breakout. But the market has already given us a couple of false breakouts at this level, and although I see higher prices ahead, I’m still not convinced that we have seen all the near-term downside that Mr. Market has in store, particularly given we are now in the historically weak month of September. Also, the improving economy is a double-edged sword from an equity investor’s perspective as they are concerned that the Fed might feel the need to raise rates sooner than currently planned.
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:
Yes, we are entering the historically weakest month of September, at least according to Stock Trader’s Almanac. However, the reality is that the average monthly loss is only -0.5%, and nearly half of the time the market finishes positive. Moreover, recent performances have bucked the averages, with solid gains in September the past two years and a robust +8.8% in 2010.
There is no doubt that the U.S. economy is strengthening while central banks flood world markets with liquidity, and global investors look to U.S. stocks and Treasuries for the unusual combination of more safety and higher returns. Hiring has surged starting with lower wage jobs but also with the expectation that higher wage jobs will soon follow. Corporate profits are at record highs and stock buybacks are raging. Also, oil prices have fallen as domestic production continues to rise. The European Central Bank has joined the other major central banks in lowering interest rates and launching its own version of quantitative easing, and much of that new liquidity should find its way into the relative safety of U.S. stocks and Treasuries.
And don’t forget, hedge funds are finding themselves way underweight in equities. After the ECB announced its stimulus program, David Tepper of hedge fund Appaloosa Management predicted that this signals the official end of the bond market rally, driving even more capital into equities. Although elevated, valuation multiples are not out of line given low interest rates and strong earnings growth expectations.
However, that doesn’t mean that the stock market is destined to go straight up. There hasn’t been a real 10% correction in nearly three years, which is twice as long as the typical interval between corrections. We are way overdue. Notably, leading sectors last week were defensive-oriented Utilities and Telecom, which is not particularly encouraging to the bulls. And of course, ECB liquidity programs have little chance of making much difference in an EU in desperate need of major structural reform (although U.S. equities will welcome the capital inflows).
The yield on the 10-year U.S. Treasury fell to less than 2.4% during the summer and closed Friday at 2.46%, so a significant weakening in Treasuries hasn’t happened yet. In fact, Jeff Gundlach of DoubleLine Funds (who predicted this year’s rally in bonds), has predicted the 10-year yield to remain between 2.2-2.8% for the foreseeable future, with the main risk being to the downside. So, there is still no consensus on the near-term direction of Treasury bonds.
