The technical picture for stocks has shifted from bearish into neutral, and our fundamentals-based sector rankings appear to have moved from bullish to neutral, as well. Thus, caution remains the order of the day until either the bulls or bears can find a catalyst — and enough recruits — to move the ball in their direction.
Notably, there has been a rather significant correction in higher-risk growth stocks and small caps that has not translated into a correction for the broader market. High-P/E and momentum darlings have been slammed. The Russell 2000 small cap index remains well below its important 200-day SMA, and the NASDAQ might test its 200-day soon, too. But the larger S&P 500 and Dow Jones stocks have been holding up just fine as the capital apparently has rotated into defensive and higher quality stocks, offering support to the overall market (e.g, the Wilshire 5000) despite the weakness in the higher-risk segments.
Among the ten U.S. business sectors, Financial and Consumer Goods/Staples were the winners last week. However, on a year-to-date basis, Utilities is still the clear leader, up about +12.5%, followed by the steadily surging Energy at about +7.5%. Healthcare remains in third place, but it has fallen a few percentage points since early March when it held the lead, and is now below +5% YTD. Consumer Services/Discretionary is the clear laggard, and in fact it is the only sector in the red YTD.
The CBOE Market Volatility Index (VIX), a.k.a. fear gauge, closed last week at 12.92, which is right where it closed the previous week. It remains firmly below the 15 threshold, indicating investor complacency about risk in their stock holdings. Although it showed some signs of life last week, VIX remains oversold and could spike up at any time, which would be bearish for stocks.
Despite the Fed’s tapering, its balance sheet has nonetheless ballooned to more than $4.2 trillion and is still growing, which has pushed return-hungry capital into equities. Improved jobs growth, strong manufacturing and services surveys, good data from housing, retail sales, consumer spending, consumer confidence, and the expectation of better earnings growth coming out of the harsh winter — all of which point to a strengthening economy. Of course, as I have said many times, earnings growth will rely upon actual top-line revenue growth from now on, rather than cost-cutting.
As Q1 earnings reporting season winds down, it appears the market is looking at a forward P/E multiple for the S&P 500 of a little over 16x, which isn’t too rich at this point of the bull market. The 10-year Treasury yield closed Friday at 2.62% and still shows no inclination to rise or fall from here, i.e., there has been neither a widely-anticipated Great Rotation out of bonds (as the Fed tapers bond purchases) nor a massive flight to their safety. And with no sign of wage inflation on the horizon, price inflation is unlikely to surface, either. Thus, longer-term interest rates may continue to confound the experts by remaining low, which supports an elevated P/E multiple in equities.
