Stocks have needed a reason to take a breather and pull back in this long-standing ultra-bullish climate, with strong economic data and seasonality providing impressive tailwinds — and plummeting oil prices certainly have given it to them. But this minor pullback was fully expected and indeed desirable for market health. The future remains bright for the U.S. economy and corporate profits despite the collapse in oil, and now the overbought technical condition has been relieved. While most sectors are gathering fundamental support and our sector rotation model remains bullish, the Energy sector looks fundamentally weak and continues to rank at the bottom of our forward-looking sector rankings.
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 fear of broader fallout from issues like Ebola, ISIS, Russian aggression, European malaise, and slowdown in China had subsided, so the market has been waiting for next big worry to spike the fear gauge and cause a selloff to test support levels. The Dow Industrials suffered its biggest weekly percentage loss in three years. After all, it is hard to break out to new highs when bullish conviction has not been recently tested and reconfirmed. Well, it found its next big worry in the fall of oil prices and all that it might be foretelling, such as defaults in the high-yield bond segment of the Financial sector and recession in global economies.
Crude oil fell another 3% on Friday to 5-year lows and 46% below the June highs after the International Energy Agency cut its outlook for 2015; and it expects prices to fall further. Tremendous increases in domestic production through enhanced recovery techniques and the prospect of energy independence in the U.S. (which once was considered an impossibility) has led to a global glut, but OPEC has decided not to reduce production. The U.S. dollar has gained 77% year-to-date against the Russian ruble.
As a result, Energy sector investments are likely dead money for the near term, although the downside might be less onerous. Moreover, those investors who sought to leverage the easy money of high oil prices and enhanced production through the high-yield market are no concerned more about their return OF capital rather than a return ON capital. Any surge in defaults could be a game-changer, but for the moment it appears that prices will remain above the profitability thresholds. Eventually, the search for higher returns through risk assets will shift away from leveraged plays and back to unleveraged investments like Technology and Industrial stocks, and that will be bullish for the broader markets.
To be sure, the Fed's monetary policies of zero interest rates and quant easing gave the U.S. economy of tremendous boost, but now the economy has its own momentum that can't be stopped with anything the Fed might have in store. As it stands, leading economic indicators are strong, GDP forecasts are being raised, job growth is the strongest since the ‘90s, and corporate profits sit at all-time highs.
But there is no denying the cautious behavior of investors at the moment. The 10-year U.S. Treasury bond yield closed Friday at 2.09% as capital flowed out of equities. Its 52-week range is 1.86-3.06. The CBOE Market Volatility Index (VIX), a.k.a. fear gauge, closed at 21.08 on Friday after reaching as high as 23.06 intraday. This is still well below the October highs that spiked above 30. Also, year to date, the healthcare and Utilities sectors (which are traditionally defensive or all-weather) are the clear leaders. And then there is the condition of Europe's economy and the imminent expiration of the ECB's long-term refinancing operations, which will result in a whole bunch of assets rolling off balance sheet just when it needs to expand it.
