Bulls Wrest Back Control Of Market Direction, Despite Global Adversity

Some weeks when I write this article there is little new to talk about from the prior week. It’s always the Fed, global QE, China growth, election chatter, oil prices, etc. And then there are times like this in which there is so much happening that I don’t know where to start. Of course, the biggest market-moving news came the weekend before last when Paris was put face-to-face with the depths of human depravity and savagery. And yet the stock market responded with its best week of the year. As a result, the key issues dominating the front page and election chatter have moved from the economy and jobs to national security and a real war (rather than police actions) against a blood-thirsty orthodoxy that, as the world now seems to universally understand, cannot be simply contained. It is suddenly better to risk being wrong but strong than to be right but weak.

In any case, the major market indexes have remained undeterred -- by either the Fed’s apparent foregone decision to raise the fed funds rate next month or the sudden wave of violence sweeping the globe -- as seasonality and a strong technical picture continue to stoke bullish conviction in U.S. stocks. Moreover, our fundamentals-based sector rankings are mostly unchanged.

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:

First a planeload of Russian tourists is bombed out of the sky. Then Paris is attacked by suicidal murderers. Then Mali gets the same. Now Brussels is in lockdown. This is not just a containment problem any longer (not that it ever really was). The civilized world seems to be coming together in the conviction that we are at war with a blood-thirsty ideology bent on religious and ethnic cleansing that would sooner see the entire world annihilated than allow infidels to inhabit it. There can be no peaceful coexistence with this line of thinking, and yet it is spreading like a cancer around the world.

At the same time, the world is coming to realize that after seven years (since the financial crisis) of global monetary policies designed to stimulate growth and inflation, there has been very little of either. It is becoming evident that different strategies are needed, if any are really needed at all. Perhaps the best idea is to normalize interest rates and focus instead on policies that take the heavy hand of government out of the picture and allows market forces to work with greater freedom.

For its part, the Fed is trying to signal as clearly as possible that they are on track for their first rate hike, come hell or high water. The fed funds futures (which tend to be quite prescient) are now forecasting a 74% chance of a quarter-point rate hike at the December 16 meeting. The 10-year Treasury yield closed Friday at 2.26%, which is up significantly from 2.06% just two weeks ago. However, there is an interesting observation about the yield curve’s response since the low in yields on October 14. The 2-year/10-year spread has flattened from 1.43% (2.33-0.90) on November 6, to 1.34% (2.26-0.92) on Friday; while the 5-year/30-year spread has flattened from 1.56% (2.84-0.56) on October 14, to 1.35% (3.09-1.74) on November 6, to 1.33% (3.02-1.69) on Friday.

Investors seem to be becoming more comfortable in the idea that the Fed will go slow, and that a small rate hike is a sign of a strengthening US economy and consumer. Retail stocks in general have shined for the past week, although the leaders have been discounters like Walmart (WMT), Ross Stores (ROST), and TJ Maxx (TJX), while higher-end mall-based stores like Nordstrom (JWN) and Macy’s (M) and Williams-Sonoma (WSM) have faltered. Nike (NKE) announced it was raising its dividend, buying back $12 billion in stock, and splitting its stock, to boot.

Commodities across the board continue to weaken, making anything and everything in this broad space (including oil) highly correlated and difficult to diversify. Moreover, the entire Industrial sector is struggling as China growth remains uncertain and global liquidity is used more for investing in Treasuries, real estate, and stock buybacks than in capital equipment and new projects. As a result, breadth is poor, leadership is narrow, and the Street continues to reduce forward estimates on sales and earnings across all sectors. But an earnings recession does not imply an economic recession, and low energy prices and strength in the dollar has not held back an improving labor market, consumption, innovation, and productivity gains.

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Disclosure: Author has no positions in stocks or ETFs mentioned.


Disclaimer: This newsletter is published solely for informational purposes and is not to be construed as advice ...

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