Stocks Remain Inside Their Long-Standing Trading Range, But An Upside Breakout Grows More Likely

The market has provided a nerve-wracking amusement park ride for those with the stomach to hang in there. Of course, the Brexit vote caused a nasty selloff due to the uncertainty of what comes next and the long-term ramifications, but the ensuing recovery was just as swift. At the end of it all, stocks are right back where they have been, mired in the same long-standing trading range but apparently (in my opinion) more inclined to find some sort-of upside catalyst. And given elevated multiples, it seems that the only thing that will allow such a breakout will be improving forward revenue and earnings guidance during the imminent Q2 earnings season. The added benefit of this would be improving market breadth, lower sector correlations, and a continued flight to quality (i.e., fundamental strength and solid earnings quality), which we would expect to benefit fundamentals-based portfolio strategies (like Sabrient’s), as opposed to strategies based purely on safety, momentum, speculation, or risk-on/risk-off (i.e., cap-weighted beta exposure).

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:

After the scary post-Brexit yo-yo, as of July 6 the broad market indexes like S&P 500, Nasdaq, and Russell 2000 are back above their 50-day and 200-day simple moving averages (although the transportation index has not), and in fact the 50-day has provided solid support the past two days on the S&P 500. As for asset class performance for the first half of 2016 (year-to-date through June 30), the S&P 500 was up +2.7%, Nasdaq Composite -3.3%, 10-year Treasury bond +15.2%, and gold +24.7%.

Defensive sectors and commodities were the strongest market segments in 1H 2016. Year-to-date through June 30, the top two performing sectors were Telecom and Utilities, up +24.8% and +23.4%, respectively, while Financial was the worst, down -3.0%. Drilling down to specific market segments, gold was up 118%, while specialized consumer services and airlines were down -29.8% and -24.4%, respectively. For the month of June alone, the top two performing sectors of the S&P 500 again were defensive sectors Telecom and Utilities, up +9.3% and +7.8%, respectively, while Financial was down -3.2%. Gold was up +20.8% in June while airlines were down -11.6%.

Corroborating the outperformance of defensive sectors in a general flight to safety was the continued strength in Treasury bonds (and record-low yields). Treasury yields hit record lows at the open on Wednesday of 1.34% on the 10-year and 2.11% on the 30-year (versus 52-week highs of 2.46% and 3.24%). Moreover, the spread between the 10-year and 2-year is only about 80 bps, as the yield curve continues to flatten (thus hurting banks and the Financial sector). CME fed funds futures are now indicating only a 13% probability of a rate hike in December. In fact, indicators currently show zero probability of a hike before then, and remarkably, there is now a slight probability of a rate cut this year.

I have to say that it seems to me that such a momentous decision (with far-reaching global and generational implications) as the Brexit vote should not be decided on a simple majority (and emotionally-charged) vote of the people. That type of thing works fine for your local ballot proposition, such as a bond issue or mandating which hours of the day a gas-powered leaf blower can be operated, but it seems that Brexit should require a bit more in the way of overwhelming conviction in order to go through. Britain voting to exit the “United States of Europe” was not entirely unlike Texas voting to secede from the United States of America (and I think we here in the US can all agree that that would be a bad thing). I think it is entirely possible that there will be tough negotiations that produce significant EU concessions (mostly related to immigration restrictions) that leads to a second referendum on whether the UK leaves the EU. Time will tell, but the uncertainty will linger.

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


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