Sector Detector: Rejuvenated Market Seeks Follow-Through, But Earnings Loom Large

As I suspected it might, the stock market bounced strongly last week. Weakness the prior week was due in part to traders exiting positions for vacation during the holiday-shortened week, protecting big capital gains, cashing out to pay taxes on capital gains, and “delta hedging” on put options. However, I’m not convinced that the pullback was sufficient to create the great buying opportunity — but it was sure a tradable bounce.

Among the ten U.S. business sectors, the big winner last week was Energy, which was up about +4.5%. Also, Financial and Industrial were each up about +3%. Defensive sector Utilities still stands alone as the year-to-date leader, up about +11%, while Energy’s strong performance last week has it in second place, up about +5% YTD. Healthcare has been the big loser as it has fallen from the penthouse to the outhouse since the beginning of March, led by the big selloff in momentum favorites from biotech and biopharma.

Wringing out some of the excesses has been healthy for the market overall. I expect that at this stage of the bull run, particularly with the Federal Reserve methodically tapering its liquidity injections, the higher-quality stocks with reasonable forward valuations that were sold off by the momentum traders will recover quickly while the lower-quality speculative stocks that surfed the wave of speculator euphoria will be left behind in a general flight to quality.

Many market commentators are warning of a similar “jobless recovery” as we saw in the 1990s. They lament the sky-high profit margins (that are likely to revert to the mean), growing income inequality, and the predominance of low-paying or part-time jobs among our anemic job growth. Moreover, most new investment and M&A in today’s high-tech society are in intellectual property or capital-intensive (rather than labor-intensive) business – whether new drilling technologies for the energy industry or Facebook’s $19 billion acquisition of WhatsApp (with all of 55 employees).

Thus, many are directing investors’ attention to emerging markets. The MSCI Emerging Markets Index is trading at a forward P/E of around 10.5x, compared with 15.5x for the S&P 500 — the biggest discount since 2006. Moreover, some of the key emerging market currencies appear severely undervalued, and there’s the potential for significant economic reforms following upcoming elections in many of the key emerging market countries.

Notably, the 10-year Treasury yield bounced from 2.60% during a mid-day dip last Tuesday, and then spiked mid-day on Thursday to close the week at 2.72% as safe haven Treasuries sold off — at least partially attributed to the EU, U.S., Ukraine, and Russia coming to an agreement in Geneva on steps to address the Ukraine crisis.

Earnings season gets into full swing this week, including McDonald’s (MCD), Apple (AAPL), Netflix (NFLX), AT&T (T), Microsoft (MSFT), Biogen Idec (BIIB), Amazon (AMZN), Starbucks (SBUX), Facebook (FB), and QUALCOMM (QCOM). Last week saw disappointments from Bank of America (BAC), Google (GOOGL) and IBM (IBM), but positive surprises from the likes of Yahoo! (YHOO), General Electric (GE), Intel (INTC), and Morgan Stanley (MS), as well as SanDisk (SNDK), which I have been touting as a top idea in recent articles.