Stocks Break Out As Investors Place Their Bets On Endless Monetary Stimulus

The market broke out to the upside, as I predicted it would -- although the breakout came a good bit sooner than I anticipated. My expectation was that stocks would remain within their long-standing trading range until a clear upside catalyst emerged, such as improving Q2 earnings reports and forward guidance. But investors aren’t waiting around. Clearly, they are positioning in advance of the emergence of such catalysts. For now, fear of missing liftoff is stronger than fear of getting caught in a selloff. Rather than take the laundry list of uncertainties -- including Brexit, the US presidential election, global terrorism, civil strife here at home -- as reasons to run for the hills, investors seem to be confident that it means a continuation of the easy money spigot of accommodative monetary policies at home and abroad, and no Fed rate hikes. Some commentators are even predicting that “helicopter money” is in the cards. The expectation is that no stone will be left unturned to shore up the economy.

In this periodic 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 ETF trading ideas.

Market overview:

Yes, the market broke out right smack dab in the middle of summer. The S&P 500 is now up about 6% YTD as of Monday’s close, and all year I have been predicting a double-digit gain by year end. However, given elevated valuation multiples, a continuation of this technical breakout will depend upon fundamental catalysts like improving forward revenue and earnings guidance. This would also help ensure improving internals, like growing market breadth, lower sector correlations, and a continued flight to fundamental quality, which we would expect to benefit fundamentals-based portfolio strategies like Sabrient’s. Notably, the fact that financials and transports have joined the rally bodes well for the bulls. Those were two lagging sectors that had been causing me some concern.

The Atlanta Fed’s GDPNow model is predicting an expected Q2 GDP growth rate of 2.4%. However, FactSet shows that 2016 S&P 500 EPS consensus estimates have dropped to $118.66, which implies a forward P/E of about 18x. Not so great. But for 2017, estimates are indicating $134.50/share, or a forward P/E of 16x, which seems ambitious.

The most unusual part of the current market action is that stocks are hitting all-time highs right after Treasury prices had just done the same. Normally, such strength in Treasuries indicates investor fear and a flight to extreme safety amidst a recessionary economic environment. But the difference today is the extreme levels of monetary stimulus (aka, free money) around the world facilitating a no-brainer carry trade and foreign capital flows into a nice safe return from US Treasuries, in addition to the money pouring into US stocks in search of even higher returns than what bonds currently offer.

Nevertheless, after weeks of falling to new all-time lows, Treasury yields have suddenly surged higher, with the 10-year Treasury yield closing Monday at 1.59% and the 30-year at 2.30%. This is up from the record lows a couple of weeks ago of 1.34% on the 10-year and 2.10% on the 30-year, but still quite low. The spread between the 10-year and 2-year (0.68%) has increased somewhat to 93 bps, but the yield curve remains relatively flat.

CME fed funds futures are now indicating a 12% probability of a rate hike in September, and 43% for at least one hike by December. This is up significantly from a couple of weeks ago (right after the Brexit vote) in which there was a distinct probability of a rate cut. In any case, monetary policy remains quite loose as M2 money supply has accelerated to an 8.2% annual rate in the first half of 2016, which is the fastest pace since 2012.

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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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