Although the large caps set new highs early on Friday, small caps and NASDAQ have not come close to their prior highs. Friday closed with extreme weakness across the board, and it was on high volume. The technical picture and our fundamentals-based sector rankings have both taken a bearish turn, so we might see more weakness ahead. But longer term, I expect higher prices, so an extended pullback likely will turn into a good buying opportunity. In any case, the rotation from speculative stocks into higher quality companies should continue, so it’s best not rush back into the lower quality speculative stocks on this selloff.
Indeed, the momentum darlings from biotech, internet, and social media have taken a severe hit. And many of the highly popular but lower quality/overvalued stocks like Netflix (NFLX) and Tesla Motors (TSLA) have been taken out to the wood shed. During cleansing periods like this, however, the market will often throw the proverbial baby out with the bathwater. Sabrient favorite Jazz Pharmaceuticals (JAZZ) is an example. It is still in great shape fundamentally, but it is either guilty by association (with biotech) or the momentum traders (weak hands) are protecting their fabulous profits, or both. Whatever the reason, longer-term investors are getting a new chance to scoop up at reduced prices high quality companies like JAZZ that had become momentum favorites.
Among the ten U.S. business sectors, Utilities has solidified its position as the year-to-date leader, up +8.2% and hitting a new intraday high on Friday and closing very near its all-time closing high.
Examining ETF money flows, the first two months of Q1 saw positive inflows for fixed income funds and negative for equity funds. Even during the big rally in stocks during February, capital did not rotate out of bonds as one might have expected. But then March saw a reversal, led by traditionally bullish sectors Financial, Technology, and Basic Materials, even though the major indexes did not advance. Of course, last week was a different story as equity funds bled redemptions. So, in retrospect, one might wonder whether February actually a bull trap.
From the standpoint of fundamental strength, the U.S. economy is strong enough to tolerate rising interest rates, but most other countries are not. Japan is implementing quant easing and Europe will soon see it, too. China is in the unenviable position of needing to address its credit bubble while still stimulating the economy. For now, it is targeting tax breaks for small businesses, replacing shantytowns with “social housing,†and funding railway construction projects. But economists are predicting U.S. annualized GDP growth upwards of 3% for the balance of this year and next. And the Dow Jones Transportation Average has been quite strong, which bodes well longer term for the Industrial sector and the economy in general.
The CBOE Market Volatility Index (VIX), a.k.a. “fear gauge,†closed Friday at 13.96, which is still quite low despite the market weakness on Friday. It has remained below 15 for the past couple of weeks, indicating an absence of significant investor trepidation.
