Headlines Drive Market Direction

Headlines continue to dominate the trading landscape, perpetuating a news-driven trader’s market rather than allowing a healthier valuation-driven investor’s market to return to favor. After all, that’s what stock market investing is supposed to be about. Narrow market breadth and daily stock price gyrations have been driven primarily by three headline generators -- oil price, the Fed’s monetary policy, and China growth. Sure, there were many other important news items, notably the sinister course of Islamic terrorism. But it was those three main subjects that have been the persistent drivers of the daily buffeting of investor sentiment, and by extension stock prices.

In particular, the fact that the Federal Reserve can’t seem to remove itself from the headlines has been a disappointment. In December, it tried to fade to the backdrop by clearing up some uncertainty about its intentions by making an initial rate hike and then laying out a convincing timeline (albeit data-dependent) for a path toward normalization. But alas market speculation continues given the stark divergence between the Fed monetary policy and all other central banks. Nevertheless, it is likely that all three headline-grabbers (oil, Fed, China) may resolve much of their uncertainty over the course of the year, thus enticing investors to return to a “flight to quality” strategy.

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:

Friday was a tough day due to renewed speculation about future Federal Reserve rate hikes, after the BLS reported that the U.S. economy added 151,000 jobs in January. This was below the expected 180,000 jobs, but wage inflation continued to growth, rising by 0.5%, and the workforce participation rate ticked a bit higher (although it is still near a 40-year low). For the week, the U.S. dollar fell hard against a basket of currencies and was down 1.9%. Then the selloff in equities continued on Monday, with stocks falling hard on high volume before recovering about half their losses by the close. The S&P 500 finished down 1.4% while a flight to safety pushed the 10-year yield down to 1.76% -- a 12-month low. Two-year yields closed near 0.67%.

Last month was the worst January for stocks since 2009, and the start of February has led to more of the same, as bulls are getting an extreme test of conviction, with critical technical support lines trying to hold. Financials in particular seem to be inordinately bearing the brunt of the fear-driven selling. The sector was already displaying the lowest forward P/E as investors evidently doubt the accuracy of consensus earnings estimates, but it continues to take direct hits. Certainly rising credit spreads in Energy sector and Emerging Market debt instruments are a concern, as is the flattening yield curve, which makes lending less lucrative. Although we all recall that the V-bottom in March 2009 launched a 6-year bull market, most investors and commentators are not expecting the same thing this time around. Equity prices have been tied to headlines generated primarily by oil prices, the Fed, and China.

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Oil price declined last week and has been struggling to hold the $30 level, which has been putting pressure on Energy and Financial sectors. As a result, oil analysts and market commentators have become progressively gloomier about the near term outlook for prices, with some price targets to the downside ranging as low as $7 to $20, and some are seeing no end in sight to the supply glut -- with predictions of a calamitous fallout in oil-exporting countries and in our own domestic oil patch (and by extension, the high yield debt market).

I worked in the oil industry for the first 18 years of my career, and I must admit that I was a believer in the “peak oil” theory in which global demand would soon outstrip an ever-dwindling supply of recoverable reserves, thus driving the U.S. to ultimately import 100% of its crude oil and force us into alternative energy sources, including nuclear. The theory suggested that shale oil and other tight formations wouldn’t be economically viable until prices reached at least $200/bbl.

But that was then and this is now, and the ingenuity and persistence of capitalists and entrepreneurs has made North America essentially energy independent, contributing to today’s worldwide supply glut. Nevertheless, these imbalances should begin to moderate this year as demand continues to grow while output declines from exhausted wells here at home (without further costly stimulation, like fracking) and oil-exporting countries (non-OPEC) reduce their capital budgets. This may lead oil to drift back into the $40-50 range sometime over the course of the year. Keep in mind, oil is a “Goldilocks” commodity that can’t be either too hot or too cold without disturbing oil producers on the low side or consumers on the high side.

As for the Fed’s path toward normalizing the fed funds rate, it is notable that the fed funds futures are currently pricing the probability of a March rate hike at 0%, a June hike at 13%, and December at only 26%, with only a 3% chance that we will see two rate hikes this year. This is a big difference from the four rate hikes telegraphed by the Fed after their first rate hike in December. The market seems to be speaking loud and clear about such a plan. In any case, investors will listen for clues in FOMC Chairwoman Yellen's congressional testimony on Wednesday and Thursday this week.

China of course remains a big question mark -- not just because of its big and growing impact on the global economy (especially emerging markets) but also because of its veil of opacity and secrecy that confounds trading and investing models and commentators. But China is highly motivated to keep its “miracle” alive and kicking and is unlikely to permit a recession to take hold, so all tools are in play including devaluation of the yuan that has been so expensive to shore up and keep pegged to the rising dollar.

Yet despite all of this noise and paralyzing headlines, U.S. equities still look attractive, with historically reasonable forward valuations (S&P 500 forward P/E around 15x), especially given the expected persistence of low 10-year yields. And in any case, if you believe that we are not on the precipice of a recession or bear market but are simply waiting for the clouds of uncertainty to pass, then you will likely miss much of the upside before you realize that bulls finally got it together. It is quite difficult to time a market entry that avoids any portfolio drawdown.

The CBOE Market Volatility Index (VIX), a.k.a. fear gauge, closed the week at 26.0, which is well above the 20 long-term average. However, we are likely entering a period of elevated volatility that may have pushed the “panic threshold” up closer to 30, so the fact that VIX has not closed above 30 this year (it has only spiked above that level intraday a couple of times) may be an indication that the market is not on the verge of a crash but rather simply searching for a bottom.

Notably, despite the harsh market conditions, ETFGI reported that global exchange-traded products (ETFs and ETPs) gathered net inflows of $13.1 billion in January 2016, and the global ETF/ETP industry ended the month with 6,180 products totaling assets of $2.85 trillion from 277 providers on 64 exchanges. During January, 43 new ETFs/ETPs were launched by 17 different providers.

Sabrient’s eighth annual Baker’s Dozen top 13 picks for 2016 launched on January 15. It is based on our unbiased quantitative GARP (growth at reasonable price) model with a fundamental final review and selection process (i.e., a “quantamental” approach). The new portfolio comprises stocks from various sectors but with the common thread that they produce finished goods and services that can be directly consumed by individuals -- including airline, cruise line, auto maker, drug maker, discount retailer, cell phone service, banking, software, and gaming -- rather than producing components (like semiconductors) or B2B services (like industrial supplies or equipment rentals).

SPY chart review:

The SPDR S&P 500 Trust (N:SPY) closed on Friday at 187.95, right near important support around 187.50, but then Monday’s selloff took it down to 182.80 intraday before a late recovery helped it close at 185.42. Price formed a bullish hammer pattern that will likely lead SPY to close the gap from Friday’s close, but we’ll have to see if bulls can take it back up inside the sideways channel between 187.50 and 200. SPY remains below all of its key moving averages, including the 20-day (at 190), 50-day (at 198), 100-day (near 201), and 200-day (near 204) simple moving averages. All are knifing downward ominously. The long-term low from October 2014 near 182 has been tested three times this year now. Oscillators RSI, MACD, and Slow Stochastic have all turned back downward after a brief rally attempt, but they are essentially in a neutral position that could turn back up at any time. If investors can shake off their fears and turn this back into a quality-driven rather than headline-driven market, the 200 level will be a challenge, but the bearish gap down from 204 at the beginning of the year should act as a magnet (long-time technicians have observed that gaps generally get filled about 80% of the time). Jeff Saut, chief investment strategist at Raymond James, has commented that the cluster of high-volume selling followed by higher-than-average buying volume indicates to him that a major bottom is trying to form.