Sector Detector: Summer Slog Likely To Keep A Lid On Further Stock Gains

Stock investors entered the Fourth of July holiday on a high note, pushing the Dow Jones Industrials Index above 17,000 and the Wilshire 5000 Total Market Index above 21,000, and even pushing the S&P 500 to a smidge above the upper trend line of its long-standing bullish ascending channel that has been in place for nearly three years. However, with the Independence Day cheer behind us, persistently overbought technical conditions, and two months of summer doldrums ahead until the Labor Day holiday, I don’t think stocks are likely to muster much in the way of further progress over the near term. This may give bears a chance to make their long-stymied move.  Although bulls should be able to maintain the upper hand in the longer term, I expect bears will finally have their window of opportunity to drive prices down (at least a little) before summer is over.

Last week I reported that among the ten U.S. business sectors, defensive and income-oriented Utilities displayed the best first-half performance. But last week was harsh on Utilities, allowing Energy to become the new leader, while Utilities fell into a virtual dead-heat with Healthcare and Technology for second place. Basic Materials also has shown good strength of late. This recent action might suggest some early signs of positioning for rising inflation and interest rates on the horizon.

Although the 10-year Treasury bond continues to remain strong with a low yield of 2.66%, this is actually a bit of a spike from the prior week’s close of 2.53%. Nevertheless, some top bond fund managers are still predicting that the 10-year yield could fall as low as 2.2% this year.

While the CPI is showing no signs of inflation, there’s no doubt that healthcare and housing costs are rising. But with the labor force participation rate on a downtrend and capacity utilization still relatively low, wage pressures and GDP will gradually rise. As a result, assuming the Fed starts raising interest rates by the end of next year, some (like Guggenheim Partners) are predicting 10-year Treasury yields to approach 4% over the next few years. Much of this capital should rotate into equities.

The CBOE Market Volatility Index (VIX), a.k.a. fear gauge, continues on its slow trek toward the depths of single digits, closing the short week on Thursday at 10.32. While some observers have been predicting single digits for the VIX, others expect an imminent reversion to the mean, perhaps all the way up to test resistance at 15. But short of a major black swan event, catalysts for such a volatility spike seem scarce.

Indeed, investor sentiment is definitely not overly bullish, which means from a contrarian basis that there is plenty of fuel available to fill the tank. For example, there has been three straight months of outflows from U.S. equity funds. Also, short interest in S&P 500 stocks has been rising, trading volume is moribund, and individual investor participation remains low.

Furthermore, corporate stock buybacks continue in earnest, and with persistently low interest rates and wage inflation, central banks can continue their liquidity programs without constraint. This means that equity prices and P/E multiples still have plenty of room to the upside.

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The author has no positions in stocks or ETFs mentioned. The materials available from us are published solely for informational purposes. They are not to be construed as advice or ...

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