Stocks were able to leverage some optimistic news and dovish words from the Fed to take another stab at an upside breakout attempt last week. Although readers have sometimes accused me of being a permabull, I am really a realist, and the reality is that the slogans like “The trend is your friend†and “Don’t fight the Fed†are truisms. And they have worked. Nevertheless, I am still not convinced that we have seen the ultimate lows for this pullback, especially given the weak technical condition of small caps.
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:
Bulls got a solid show of support from friends in high places last week. Of course, the biggest drivers of the stock market’s strong performance has been 1) signs of an improving economy, 2) global liquidity provided by dovish central bankers, and 3) global turmoil pushing cautious investors with all that liquidity in their hands into the relative safety and quality of U.S. securities of all types. The FOMC statement on Wednesday indicated no change in the dovish policies and no threat of an imminent move to raise short-term interest rates. ECB quant easing has led to a fall in the British pound and the euro. This has led to a notable strengthening in the U.S. dollar, which has helped keep inflation low, thus giving the Fed room to remain accommodative, which in turn is supportive of elevated valuation multiples in equities.
The 10-year Treasury closed Friday at 2.57%, which is down slightly from the prior week. I still think there is greater downside potential in the 10-year yield, especially given global liquidity and the resulting demand for the safety of U.S. Treasuries. Inflation is hard to find, and many economies around the world are trying to stave off recession and deflation (including Europe and Japan). Low interest rates could be with us for a while.
However, there are still signs of more weakness ahead in stocks, before the eventual launch into the widely anticipated year-end rally to new highs. The week following a triple (or quadruple) witching options expiration day (like last Friday) is usually a down week, according to Stock Trader’s Almanac. Also, the technical picture is not giving me confidence, as described below, and short interest has increased again.
The CBOE Market Volatility Index VIX, a.k.a. fear gauge, closed Friday at 12.06, which of course is down from the prior Friday given the market breakout. It is well below the important 15 level and also back down below its 50-day simple moving average. However, the 50- and 200-day SMAs appear to be on a collision course, with the 50-day threatening to cross up through the 200-day, which would be bearish for stocks.
Year-to-date, the S&P 500 large cap index is up +8.8% total return, while the Russell 2000 small cap index is up less than +1.0%, and non-U.S. stocks are up only about +3.5%. Many market observers believe the lag in U.S. small caps is appropriate given the outperformance of small caps last year that boosted valuations out of balance.
After 5.5 years of a liquidity-fueled bull market, many observers are saying the market is getting long in the tooth and doomed to end soon. However, bull markets don’t die of old age. In fact, advanced age alone is rarely a sure-fire predictor of flagging performance in any activity, except perhaps professional sports. Take music, for instance. I just attended the Diana Ross concert earlier tonight at the Santa Barbara Bowl, and she is better than ever at age 70. Earlier this year, I attended a Paul McCartney concert in Kansas City, and at 73 he is still phenomenal. Likewise, Sabrient founder, former NASA scientist, and stock-picker extraordinaire David Brown is also a septuagenarian, and he is as good as ever.
