Stock Bulls Shake Off Worries About Mounting Global Dangers

As expected, August brought more volatility. Early in the month, the large cap, mid cap, and small cap indices all set new all-time closing highs while the CBOE Volatility Index (VIX) hit an all-time low. But then tough resistance levels failed to yield, the expected late-summer volatility set in, and support levels were tested. Nevertheless, the intra-month swoon (3% on the S&P 500) turned into a buying opportunity for the bulls, and by month-end the S&P 500 managed to eke out a small gain, giving it five straight positive months. Then the market started the month of September with a particularly strong day to put those all-time highs once again within spittin’ distance…that is, until North Korea detonated a hydrogen bomb in its testing area, while massive hurricanes created havoc. But by this past Friday, bulls had recovered key support levels.

One can only wonder how strong our global economy would be if it weren’t for all the tin-pot dictators, jihadis, and cyberhackers that make us divert so much of our resources and attention. Nevertheless, prospects for the balance of 2H2017 still look good, even though solid economics and earnings reports have been countered by government dysfunction, catastrophic storms, escalating global dangers, and plenty of pessimistic talk about market conditions, valuations, and credit bubbles. Thus, while equities continue to meander higher on the backs of some mega-cap Tech sector darlings and cautious optimism among some investors, Treasuries are also rising (and yields falling) to levels not seen since before the election in a flight to safety among other investors.

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. In summary, although September historically has been the weakest month of the year, our sector rankings still look moderately bullish, while the sector rotation model has managed to maintain its bullish bias, and overall the climate still seems favorable for risk assets like equities. Read on....

Market overview:

So much to talk about these days. Where to start? There have been strong economic reports, with PMI Services, ISM Manufacturing, and ISM Non-Manufacturing all rising impressively. Corporate earnings season proved solid, with support from a weakening US dollar (especially helping the multinational firms). Copper, a key industrial metal that had been in a 5-year downtrend, has remained strong ever since the election. Consumer Sentiment is strong, as is jobs growth with unemployment at a low 4.3%. Real GDP growth in Q2 was revised at the end of August to an annualized rate of 3.0%, and the Atlanta Fed’s GDPNow predicts Q3 to come in at 3.0%, as well. But then there are distractions like North Korea detonating a hydrogen bomb, the temporary debt ceiling suspension (which may make it difficult to achieve both spending cuts and tax cuts in December), and Trump’s rescission of Obama’s DACA benevolent decree, choosing instead to force our 535 elected legislators to decide whether such important immigration policy should be the law of the land (although he will revisit it if they fail to decide). Such things distract from the bipartisan fashioning of important fiscal policies, e.g., tax cuts, regulatory reform, infrastructure spending, so as to broaden and strengthen this slow recovery before the next recession inevitably hits.

I could go on and on, but instead let’s just focus on the current market conditions and valuations.

Year-to-date through the end of August, the S&P 500 total return hit 11.9%, with 9 of the 10 major business sectors positive. As of Friday’s close, the SPDR S&P 500 Trust (SPY) was up +10.3%. Among sectors, using the 10 US sector iShares, the top-performer YTD through Friday is Technology, up +22.8%, followed by Healthcare at +20.1%, boosted by a sudden resurgence over the past couple of weeks in the biotech segment, while Energy is the worst at -15.5%, followed by Telecom at -12.5%. Utilities (+13.7%) also has been a steady performer this year as reliable cash flow and solid dividend yields have attracted income investors. Since the November presidential election, the S&P 500 is +15.1%; however, after an initial broad-based rally in the wake of the election, so far in 2017 its performance has been dominated by the mega-caps in a narrow, momentum-driven, low-volatility market.

This might sound obvious, but the best climate for a “healthy” stock market and for fundamentals-based GARP stock pickers (like Sabrient) is when fundamentals matter to investors, and when investors are aligned with the sell-side analyst community on where the growth opportunities lie (market segments and individual companies). This generally manifests in good market breadth, low sector correlations, and high performance dispersion among individual stocks, as investors pick their spots for investments in the best companies for solid growth at attractive prices. This is how the markets behaved late last year after the election uncertainty was lifted.

This year, however, although Sabrient’s January Baker’s Dozen is outperforming the S&P 500 (as of 9/8/17), the overall market has returned to more of that narrow, momentum-driven climate, led by the mega caps, similar to what we experienced in late 2015, which we would not look upon as healthy or sustainable. This largely has been driven by the preponderance of capital flows into passive products that are overwhelmingly cap-weighted. Below is a chart comparing the performance of the market-cap-weighted S&P 500 (SPY), the equal-weight S&P 500 (RSP), and the equal-weight Russell 2000 (EQWS) to illustrate the lack of breadth. The performance differentials are striking. Not only has the cap-weighted SPY (+10.3% YTD) diverged from the equal-weighted RSP (+7.7%), but the equal-weight small caps (EQWS) has badly underperformed so far this year (+0.1%). On an encouraging note, small caps greatly outperformed during the late-August rebound, along with other riskier segments like biotechs, e.g., the SPDR S&P Biotech ETF (XBI), and retail, e.g., the SPDR S&P Retail ETF(XRT).

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Disclosure: The 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 or ...

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