Another solid year for U.S. equities came to a close. But it's not like everyone is jumping up and down with enthusiasm, which is a good thing. With plenty of bogeymen in the closet and under the bed, there is little in the way of irrational exuberance. Although some commentators noted that 2014 finished up much the same as 2013, there was really quite a bit of difference between the past two years, primarily in the way of lower correlations in 2014 as opposed to the all-boats-lifted environment of 2013. Looking ahead, 2015 looks promising for further gains, but not without bouts of volatility. In fact, it might look a lot like 2014.
In this weekly update, I give my view of the current market environment, offer a technical analysis of the S&P 500 (SPX) 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:
As we see the close to yet another successful year for the U.S. stock market, we can look back on 2014 and recall the many bogeymen that caused investor consternation. There was the end of the Fed's tapering of QE3 (although maturing securities are still being reinvested rather than retired). There was the huge collapse in oil prices (and still falling today), causing major disruptions in global markets. Then of course we had the slowdowns in China, Japan, and Europe — and Greece is again in crisis mode. There was major turmoil in Russia and the Ukraine. We witnessed the sudden emergence of ISIS as a terrorist organization with its own army (and social media savvy). There was the fear of Ebola spreading into a global epidemic. And here at home, we had the uncertainty surrounding implementation of Obamacare, as well as the mid-term elections putting the GOP in control of both houses of congress. Did I miss anything?
The Dow Jones Industrials blue chips, the S&P 500 large cap index, and the NASDAQ 100 ended the year up about +7.5%, +11.3%, and +17.4% respectively, while the S&P MidCap 400 (MDY) gained about +8% and the Russell 2000 small cap index gained only +3.7%. The Russell 2000 made an attempt to break out above strong resistance at 1200, but ultimately failed. NASDAQ Composite at one point looked ready to challenge the 5,000 level for the first time in nearly 15 years, but couldn't gather enough bullish conviction before the year ended. The MSCI emerging markets index finished down -6%. Defensive strategies like low volatility and dividend yield outperformed in a general flight to quality.
Still, with leadership from large caps and defensive strategies, total capital in U.S. ETFs surpassed the $2 trillion mark. In addition, fixed income indexes rose in 2014 as long-dated yields continued to decline despite the Fed's tapering of its quant easing (bond buying).
Among the ten U.S. business sectors, the top performers for the year were Utilities (+25%), Healthcare (+24%), and Technology (+19%), and all spent a lot of time during the year near the top of Sabrient's forward-looking fundamentals-based SectorCast rankings. The worst performer by far was Energy, which is not surprising given the 50% haircut in oil prices. Also showing lackluster performance were Telecom and Basic Materials, which both spent a lot of time at the bottom of our sector rankings. Consumer Discretionary and Financial both showed good late year outperformance to make up some ground.
Economic reports continue to impress, at least domestically. Redbook weekly retail sales report showed a robust +5.4% year-over-year increase. Consumer confidence rose from 88.7 to 92.6, which is quite strong. Also, U.S. manufacturing activity continues to expand despite the struggles of overseas economies.
Leading economic indicators are strong, job growth is the strongest since the ‘90s, and corporate profits sit at all-time highs. Strong GDP growth is expected to continue into 2015 and beyond, which should propel equities to new heights, although the future for long-term bond prices is not as clear. Although the near-term will likely provide further flattening in the yield curve, eventually economic health will demand higher long-term rates and a steeper yield curve.
The IPO market last year was the busiest since 2000, and the Healthcare sector was buoyed by FDA approval of the most new drugs in 18 years, including many high-priced drugs that address rare conditions and orphan diseases.
For several years, oil production has been climbing in the U.S. and Canada, and there has been a lot of recovery among oil fields in Iraq and elsewhere. In addition, rising demand in China and India and other developing nations have kept supply/demand in balance. But North American production kept climbing far beyond expert predictions, while slowing growth and/or recession in China, Japan, and Europe along with rising fuel efficiencies in the U.S. led to reduced demand. With traders and speculators no longer willing to keep the price artificially high due to geopolitical concerns, oil prices plummeted quickly, plunging much further than anyone thought possible. Sell-side analysts covering the Energy sector began slashing earnings projections once it became clear that lower prices were likely here to stay.
But asset classes tend to overshoot in both directions, and I believe we will see oil stabilize soon. Energy stocks highly dependent on oil prices might be dead money for the foreseeable future, but it is not a bad idea to begin accumulating them in long-term accounts, particularly those stocks paying a reasonable dividend with hedges in place. And the toll-taker type companies with locked-in pricing (including pipeline MLPs), which were the proverbial babies thrown out with the bathwater, might be the best long-term accumulation targets of all. Although oil prices may decline further in the near term, they likely will return to a more normal trading range. And in any case, the overall impact is positive for virtually all other segments of the economy.
