Earnings, GDP Take Spotlight Off The fed

 | Apr 13, 2015 01:00PM ET

As we get into the heart of earnings season and anticipate the GDP report for Q1, the investor spotlight has been taken off the Federal Reserve and timing of its first interest rate hike, at least temporarily. Even though Q1 economic growth will undoubtedly look weak, the future remains bright for the U.S economy – even though many multinationals will struggle with top-line growth due to the strong dollar – and any near-term selloff resulting from weak economic or earnings news should be bought yet again in expectation of better results for the balance of the year. High sector correlations remain a concern, reflecting herd-like risk-on/risk-off behavior rather than thoughtful stock-picking.

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

Similar to Q1 2014, it appears that severe winter weather in the US is going to reveal its harsh impact on Q1 economic activity, which is likely to show economic growth near zero or even negative. GDP is scheduled to be released on April 29. Other negative factors include cutbacks in Energy sector spending, the West Coast port slowdown, and the strong dollar. Already, we have seen consumer spending flat or declining in December, January, and February, jobs growth has slowed, and U.S. retail sales had its worst 3-month performance since 2009. Nevertheless, most economists are still forecasting positive growth, so investors might decide to sell first and let the dust settle if/when bad numbers are actually released.

With the reduced expectation for corporate earnings, the S&P 500 has a forward valuation that has reached about 17x. Moreover, the CAPE (cyclically-adjusted P/E) has reach about 28x, which is the highest since the pre-meltdown years of 1928 and 2007.

Of course, the U.S. 10-Year Treasury was yielding around 4.5% in July 2007, whereas it closed last week at 1.95%, so the equity markets can justify higher valuation multiples. Nevertheless, a poor GDP report could send equity investors scurrying for cover while the 10-year yield would likely retreat to its January low near 1.7%. But I would take such circumstances as yet another buying opportunity in anticipation of better economic news going forward, given the milder weather. There is still underlying US economic strength and a cautious optimism of continued recovery, despite the strong dollar. With their general focus on the domestic market, small caps in particular should continue to thrive.

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The Fed has had it ZIRP (zero interest rate policy) in place since December 16, 2008. Today, given the tight credit spreads (which indicates optimism about continued recovery), low unemployment (near the Fed’s target), and a strong equities market (that is still somewhat undervalued relative to bonds), some are predicting the first fed funds rate hike will finally arrive in June. However, given the absence of inflation and a strong (and strengthening) dollar, I think the Fed might choose to hold off until September, particularly if the Q1 GDP growth is weak.

The VIX, a.k.a. the 'fear gauge', closed Friday at 12.58, which is now well below the 15 threshold between investor fear and complacency. Notably, ConvergEx reports that the average price correlation among the 10 S&P 500 business sectors continued to be quite high at 82% (although Energy stocks were 53% correlated). Moreover, EAFE stocks (in US dollars) also showed 82% correlation to the S&P 500, while emerging market stocks showed 77% correlation. As for high yield bonds, they showed only a 57% correlation to the S&P 500. Of course, it’s much more preferable for there to be low correlations reflecting investor selectivity in their choices, rather than herd-like risk-on/risk-off behavior.

SPY Chart Review

The SPDR S&P 500 (ARCA:SPY) closed Friday at 210.05 after a strong week. Once again, it found reliable support at the lower uptrend line of the long-standing bullish rising channel, bolstered by the 100-day simple moving average. Each test of support led to a successively smaller bull flag continuation pattern, and only time will tell as to whether the latest bounce will lead to a challenge of the February highs near 212. Oscillators RSI, MACD, and Slow Stochastic are all on a bullish trajectory. In last week’s article, I predicted a strong move one direction or the other but with an expectation that it would be to the upside. We’ll see whether the bulls can keep it going given the anticipation of market-moving earnings and economic reports that will come out over the next few weeks, and of course the historically weak month of May lurking on the horizon. Below the 100-day SMA and the uptrend line resides the critical 200-day SMA (around 202) followed by round-number support at the 200 price level.