Rankings Remain Bullish On A Promising Q1 Earnings Season

Given all the geopolitical drama and worrisome news headlines – ranging from tensions with Russia and North Korea to “Brexit 2.0” and “Frexit” to uncertainties of Trump’s fiscal stimulus to the looming debt ceiling – it’s no wonder stocks have stalled for the past several weeks. Especially troubling is the notable underperformance since March 1 in small caps and transports. Nevertheless, economic fundamentals both globally and domestically are still solid. Global growth appears to be on a positive trend that could persist for the next couple of years, and Q1 earnings season should reflect impressive year-over-year corporate earnings growth, although not without its disappointments – as we already have seen in bellwethers like Goldman Sachs (GS), Johnson & Johnson (JNJ), and International Business Machines (IBM).

I continue to like the prospects for US equities for the balance of the year. I expect breadth will be solid, correlations will stay low, and dispersion high such that risk assets continue to look attractive, including high-quality dividend payers and growth stocks, particularly small caps, which I think will ultimately outperform this year despite their recent weakness. All of this bodes well for stock-pickers.

In this periodic update, I give my view of the current market environment, offer a technical analysis of the S&P 500 chart, review Sabrient’s weekly fundamentals-based SectorCast rankings of the ten U.S. business sectors, and then offer up some actionable ETF trading ideas. Overall, our sector rankings still look bullish, although the sector rotation model has, at least temporarily, moved to a neutral stance as the short-term technical picture has become cloudy. But after the pro-EU election results in France on Sunday, stocks may be ready for an upside breakout, no matter what Trump accomplishes in this final week of his first 100 days on the job.  Read on....

Market overview:

The market has been going through a bit of a defensive rotation since March 1. I must admit that it is dispiriting to see how the initial exuberance following the presidential election has subsided, at least until President Trump demonstrates he can deliver his widely-anticipated fiscal stimulus, including healthcare, tax, and regulatory reform, plus some sort of infrastructure spending package. Oh, and by the way, we are rapidly coming up on the debt ceiling and a government shutdown, so we need to pass a federal budget, to boot. All in a day’s work, right? So yes, I expect stocks will see increased volatility from time to time when the circumstances cause correlations to rise in a risk-on/risk-off fashion, especially in response to any news regarding Trump’s policies or global saber-rattling.

After the SPDR S&P 600 Small Cap ETF (SLY) peaked on December 9 (with an 18% post-election gain), it has since fallen about -4.2%, while the SPDR S&P 400 Mid Cap ETF (MDY) is up a modest +1.2% and the SPDR S&P 500 Large Cap ETF (SPY) is up a respectable +3.6%. Nevertheless, passage of any semblance of Trump’s stimulus plans should be especially beneficial to small caps.

It is notable that the initial “Trump Bump” favored Financial and Materials sectors, but more recently both have slumped while Technology and Healthcare have become two of the best-performing sectors. Year-to-date, the Technology sector is the leader, up about +12%, followed by Healthcare, Consumer Staples, Consumer Discretionary, and Utilities, while Industrial and Materials have been flat, and Financial, Telecom, and Energy have been laggards. This further illustrates to me that while investors are generally cautious at the moment, they still see Tech names as being uniquely poised to thrive as providers of devices, parts, and services to all other sectors and consumers, and to both domestic and international customers, provided that there is at least some global growth. And it’s worth pointing out that a strong Tech sector historically bodes well for the U.S. economy and the stock market.

Meanwhile, homebuilders are in their own little world, continuing without worry on a steady upward march as demand for homes increases, perhaps in response to the strengthening economy, rising wages, and fears that mortgage rates are going to rise. Home starts and existing home sales (10-year high!) outperformed again in the latest data. iShares US Home Construction ETF (ITB) has gone straight up this year even as the broad indexes began to falter after March 1. It is up +3.1% since March 1 and +17% YTD. But there’s another Consumer sector segment that still can’t catch a break, and that of course is retail. Indeed, the “Amazon effect” is the widely-accepted bogeyman. But the situation for brick and mortar stores is even worse than it seems for retailers when you consider that Amazon.com Inc (AMZN) is up +20% this year, so its 30% weighting in the S&P 500 retail index has lifted the index by 8.5% despite the struggles of so many other retailers. Nevertheless, it’s worth noting that although the SPDR S&P Retail ETF (XRT) is down -2.7% YTD, it actually broke out to the upside late last week (without help from AMZN, which was flat) and might have legs.

After being a big beneficiary of short-covering and easy year-over-year comps during 2016, Energy is down over -10% so far this year. (But all is not lost as oil prices are holding up pretty well going into summer driving season, while crude oil inventories declined for the second straight week, and there may be a consensus within OPEC to extend their production cuts.) Likewise, the Financial sector enjoyed the biggest post-election pop, but has languished recently, likely due to a combination of a flatter yield curve and lower commercial lending among banks than was expected after the election. In addition, transports and small caps were looking distressingly weak on April 13, but like retail they both got a nice bounce last week. It is important that both show leadership for a sustainable bullish trend to resume.

Nick Colas of ConvergEx recently wrote about the big drop in asset price correlations, especially among US equities. He considers this to be the most important trend since the election. Sector correlations dropped from the 75-90% range to below 60%, which has given a renewed opportunity for outperformance to skilled stock-pickers. Also, by getting away from highly correlated risk-on/risk-off behavior, there has been lower overall equity market volatility. However, he also pointed out that correlations have started to creep back up over the past couple of months while market leadership has narrowed. For example, Apple (AAPL) alone represents 17% of the YTD gain in the S&P 500 and 23% of the Dow’s gain, while just five companies – AAPL, Amazon.com (AMZN), Facebook (FB), Alphabet (GOOGL), and Philip Morris (PM) – represent 32% of the S&P 500’s YTD gain.

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Disclosure: The author has no positions ...

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