Neutral Indicators, Mixed Reports, Sector Rotation Model Still Bullish

 | Feb 09, 2015 11:32PM ET

Volatility continues as the parade of mixed earnings and economic reports marches along amidst a backdrop of global unrest and economic uncertainties. This has led to a neutral near-term outlook for both the technical picture and fundamentals-based sector rankings. Nevertheless, the longer-term trends appear to favor further flattening of the yield curve and continued strength in the dollar, gold, volatility, and equities.

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.

h3 Market overview:/h3

Last week, stocks finally got it together to register a +3% gain, even though it gave some back on Friday on the heels of a robust employment report that made investors worry that the Fed now has more reason to declare victory in its dual mandate (of unemployment and inflation targets) and raise the fed funds rate. With the big fall in oil prices, consumers are taking their savings from the pump directly into the stores, and retailers reported strong January sales while the ISM Services report clocked in at a robust 56.7.

There was some consternation among investors about the weaker GDP, which registered only 2.6% in Q4 versus the 5% annualized growth in Q3. However, Scott Minerd, CIO at Guggenheim, wrote that all the surprise and fuss completely misses the underlying strength hidden behind the headline number. In particular, although it was falling net exports that subtracted a full percentage point from GDP growth, net exports appeared weak only because imports were so strong, growing at an annualized rate of +8.9%. Moreover, household consumption has been the biggest driver of GDP growth, which is a big positive.

So, consumers are spending, and there are signs that wages are starting to grow, which would further support consumer spending, as would continued strengthening in the housing market. Also, federal, state, and local government spending is on the rise. In addition, global M&A totaled over $230 billion in January, which is 28% more than last January. I also find it fascinating that global semiconductor sales hit a record $336 billion during 2014, which is nearly 10% higher than 2013.

On the other hand, Jeff Gundlach, CIO of DoubleLine Capital, made a few recent public observations of his own, saying at the Inside ETFs Conference that, “The Federal Reserve seems hell-bent on raising the funds rate, but there’s no fundamental reason to do so. It’s just because they don’t want to be at zero when the next recession comes.” He also pointed out that U.S. equities have never finished positive for seven straight years (and of course, we just completed a sixth straight year of positive returns since the Great Recession ended).

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Another wild card for which it is difficult to predict the eventual outcome is that 17 central banks have cut rates, which is the type of drastic action not seen since 2008. It’s hard to predict how this will impact an already strong U.S. dollar, but it has led many observers to say that the Federal Reserve can’t possibly raise rates in such a climate without worsening the situation for multinational firms trying to sell in overseas markets. My view is that we will get a token raise of a quarter point later this year, but nothing beyond that until next year.

Although many market observers are citing lower forward valuations and quant easing in Europe as reasons to look to European equities rather than U.S., I see this as just a speculative play on "mean reversion.” Although it may indeed play out for awhile, in my view QE is really about asset inflation rather than real reform and improvements in competitiveness and productivity. So, at the end of the day, the U.S. is still the engine for growth.

Last week’s strength in the equity markets led the CBOE Market Volatility Index (VIX), a.k.a. fear gauge, to close Friday at 17.29, as it continues to gyrate around the important 20 threshold that suggests real fear.

So, the trends appear to favor a flattening yield curve and continued strength in the U.S. U.S. dollar, gold, volatility, and equities (in the U.S. and elsewhere). However, we are likely in a stock-pickers market in which favored stocks will be those with higher quality -- rather than a blind adherence to the broad market indexes or big bets on speculative names.

h3 SPY chart review:/h3

The SPDR S&P 500 Trust (NYSE:SPY) closed Friday at 205.55. After closing the prior Friday slightly below the 100-day SMA and testing support from the lower trend line of the long-standing bullish rising channel and round-number support at 200, stocks enjoyed a strong week and finished the week up about +3%. SPY price is back above both its 20-day and 50-day simple moving averages. Oscillators are showing RSI is still in neutral and MACD is flashing a buy signal, but Slow Stochastic has again cycled back up to overbought territory and is pointing toward consolidation or a slight pullback. The bearish head-and-shoulders pattern that might have been forming seems to be a distant memory, but the prior price gap down at 190 remains something of a magnet. The neutral symmetrical triangle I mentioned last week seems to have morphed into a neutral sideways channel as shown (now corresponding to the current position of the Bollinger® Bands), which is still more likely to resolve as a continuation pattern (i.e., bullish). However, it’s also likely that we will get a longer period of consolidation before there is enough conviction to go higher. So, conflicting signals remain for the moment. Lower support levels reside at the 100-day SMA and the lower uptrend line, which are both near 201, and then the critical 200-day SMA near 198.