Volatility Continues As Earnings Reports Create Excitement And Despair

Volatility reigned in January on elevated volume as stock investors shifted their focus from global events to U.S. earnings reports, which have ranged from amazing (e.g., Apple) to crushing (e.g., Microsoft). Although the earnings reports have brought plenty of surprises, the volatility is no surprise, as I and many other market commentators predicted for the New Year. Still, although the road may be bumpier than the past couple of years, the path of least resistance appears to be up, and the main question is whether small caps and emerging markets will make an attempt to regain past glories or if U.S. large caps must continue to carry the load.

In this weekly 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 trading ideas, including a sector rotation strategy using ETFs and an enhanced version using top-ranked stocks from the top-ranked sectors.

Market overview:

The Wall Street Journal reported that the S&P 500 experienced average daily swings of 1.5% during January. If it continues, it would make 2015 the most volatile year since 2011 when the Eurozone crisis hit. Last year, the S&P dropped more than -3.5% in January. This year, the S&P 500 closed the month down -3.1% while German equities closed up +7.2% and the iShares MSCI EAFE Index Fund (EFA) was up +2.2%. It’s pretty evident that this will not be a risk-on, all-boats-lifted kind of year.

After a streak of eight consecutive quarters of earnings growth, the estimates are indicating that the streak may be ending soon. According to FactSet, Wall Street was expecting +4% earnings growth in the S&P 500, but after a rash of downward revisions, overall growth (or lack thereof) is estimated at -2%, with the most optimistic earnings estimates for 2015 have fallen from around $133 average per share to nearly $125, which of course is driven mostly by the pratfall of the Energy sector, falling from a Q1 2015 estimate of +3.3% from several months ago to a current estimate of -53.8%. Harsh.

Already, earnings season has shown major stumbles in names like Caterpillar (CAT), Ford (F), Procter & Gamble (PG), and Microsoft (MSFT). But on the other hand, we saw strong reports and nice upside moves in names like Google (GOOGL), Apple (AAPL), Amazon.com (AMZN), Boeing (BA), Visa (V), and D.R. Horton (DHI).

Volatility has increased across all assets. The CBOE Market Volatility Index (VIX), a.k.a. fear gauge, closed Friday at 20.97, which is back above the important 20 threshold that suggests real fear, but still above the 30 level that indicates panic. Asset correlations are relatively high across the board, as well. As expected, the new reality is that while VIX averaged around 14 in 2014, it closed above 15 every day in January and averaged above 19.

Some people are saying that now is time for a reversion-to-the-mean in emerging markets and Europe, even though they admit that the U.S. economy is in the best condition of any economy in the world. It’s kind of like a Dogs of the Dow strategy in which buying the underperforming companies tends to outperform, and they see more upside opportunity in Europe, China, and India (i.e., “Dogs of the World”). Given that Fed quant easing has ended while Europe’s has just begun, U.S. corporate profit margins appear to be at a peak and destined to fall, and the strong dollar is hurting U.S. earnings. Furthermore, the argument goes that QE in Europe will withdraw duration from their market as yields are driven lower, and so asset prices will rise -- particularly equities, which are of course a long-duration asset by definition.

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


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