Bulls found fresh legs on Wednesday with support from the FOMC, despite the reluctance of Greece to “play ball” with its creditors, which has been depressing investor sentiment. Everyone seems to agree that the unresolved debt crisis in Europe is the main thing holding back global economic recovery and the snorting stock market bulls. To be sure, the situation in Europe is not good.
The worry is that Greece might be too far gone to save, and then others will fall in a domino effect. To comply with the European Banking Authority’s stress tests, European banks must raise capital and deleverage their balance sheets, so they are unloading their government debt holdings—but this hinders credit and economic growth. It’s a catch-22.
Nevertheless, the “risk-on” trade continues, as emerging markets, Nasdaq, small caps, and commodities are the leaders, while U.S. Treasury bonds are lagging. Among the 10 sector iShares, Basic Materials (IYM) and Technology (IYW) have been the leaders this week—with IYW getting a big boost from Apple Inc. (AAPL) after its incredible earnings report on Tuesday. Apparently, investors believe that the U.S., Asia, and emerging markets can weather whatever storm that emanates from Europe.
The release of the FOMC Policy Statement gave stocks and gold prices a boost, while knocking down the dollar. Although they projected somewhat slower GDP growth, they also indicated that the fed funds rate would like stay rock-bottom at least through 2014, and they left open the door for further policy action, assuming inflation remains low and unemployment high. “Don’t fight the Fed” was the mantra that goosed the bulls.
However, economic growth will continue to be sluggish until the dollars that have been printed by the Fed actually makes it into the economy.
The M1 Money Multiplier (MULT) is the ratio of M1 money supply to the St. Louis Adjusted Monetary Base. It essentially reflects the amount of money individuals and businesses have for consumption or investment relative to the money available for banks to lend. Since the bull market in equities and bonds began in the early 1980s, MULT has steadily declined from around 3.0 to below 1.0 today (0.833 on 1/11/2012). But when the financial crisis hit in 2008, MULT fell hard even as the Fed expanded its balance sheet. It fell below 1.0 for good in July 2009. This means that there is no inflation in sight as each dollar injected into the banking system is producing only about 83 cents in economic value.
But with the latest Fed report showing $1.52 trillion in excess reserves versus only $94 billion in required reserves, there is a lot of liquidity in the system that can be deployed once banks feel the risks are manageable. Stock valuations and earnings yield are still quite reasonable, especially compared with the investment alternatives. So, any sign that Europe is getting its act together while U.S. economic reports improve should further improve investor confidence—bringing more of those reserves into the capital markets.
To this end, the Fed is trying to help support the ECB in keeping European banks liquid and sovereign debt manageable, and they are doing it through currency swaps. As of last week, the total had reached $103 billion in what are essentially loans to the ECB. Since the financial crisis of 2008, the Fed’s balance sheet has jumped from about $850 billion to about $2.75 trillion due to quantitative easing, i.e., QE1 and QE2. Now we are seeing something of a mini-QE3 in the form of these currency swaps with Europe. Whereas most of the dollars printed for QE1 and QE2 remain in circulation, currency swaps with the ECB are expected to be unwound and removed from the Fed’s balance sheet as credit conditions stabilize.
As for earnings reports in the U.S., what more can be said about Apple Inc. (AAPL)? This juggernaut blew away all analyst expectations with $13.87 per share in earnings on $46.3 billion in sales and 44.7% gross margin. They once again moved into a virtual tie with Exxon Mobil (XOM) for the largest market cap—at around $417 billion. Apple has now accumulated $97.6 billion in cash, and with cash continuing to pour into their coffers, they will likely institute a dividend or stock buyback program. If Apple starts paying a dividend of something around 2% or so, it would open up its stock to income investors to join forces with the growth-oriented investors that have driven the stock for so long. (AAPL has been rated Strong Buy in Sabrient’s quantitative ratings algorithm.)
The SPDR S&P 500 Trust (SPY) closed Wednesday at 132.56. By the way, this popular ETF recently crossed over the $100 billion asset threshold—very impressive, and an indicator of the continuously growing popularity of exchange-traded funds.
The SPY chart still looks strong and seems to want to consolidate in place while working off its overbought technicals. Although many chartists are calling for a massive selloff due to severely overbought conditions, I don’t think a selloff is imminent. Sure, I would still like to see RSI, MACD, and Slow Stochastic all complete a cycle back down to short-term oversold, which would give the market better footing from which to march higher, but it could plug along on an upward path for a while the way it’s going.
The first line of support is around 128, followed by the uptrend line shown, which is now crossing through the 200-day simple moving average. Also, the 50-DSMA (not shown) is on the verge of crossing up through the 200 in what is generally called a bullish “Golden Cross,” while the 50-day exponential moving average already crossed up through the 200-DEMA on January 9.
With or without a substantial pullback—perhaps due to a shock out of Europe as the catalyst—I continue to think that SPY soon will challenge its 52-week highs from last May, near 137. Low trading volume during the recent market strength has been a key concern, so fresh cash entering from the sidelines would be a welcome development.
The VIX (CBOE Market Volatility Index—a.k.a. “fear gauge”) spiked on Wednesday to a low of 17.15 before closing the day at 18.31. It has remained below the important 20 level since last Thursday, although it has tested support-turned-resistance at 20 a couple of times. This is bullish for stocks as it indicates a lack of investor fear. Some observers are calling for a market reversal due to the low VIX, but VIX has never been great for market timing. It could stay low for quite a while.
The TED spread (indicator of credit risk in the general economy, measuring the difference between the 3-month T-bill and 3-month LIBOR interest rates) has flattened a bit over the past week since it was turned away at the 60 level at the beginning of the year. It closed Wednesday at 52.10 bps. This level still indicates elevated investor worry about bank liquidity and a preference for the safety of U.S. Treasuries. Nevertheless, there is a potential trend change underway that might be indicating renewed investor confidence.
In case you missed it, Sabrient’s annual “Baker’s Dozen” Top 13 Stocks for 2012 were unveiled on January 5 in a free live WebCast. Sabrient’s founder and chief market strategist David Brown was the main speaker, and Luke Rahbari of Stutland Volatility Group offered up his suggestions on how a trader might execute options trades on some of the names on the list. The full report and video replay are now available here.Latest rankings:
The table ranks each of the ten U.S. industrial sector iShares (ETFs) by Sabrient’s proprietary Outlook Score, which employs a forward-looking, fundamentals-based, quantitative algorithm to create a bottom-up composite profile of the constituent stocks within the ETF. In addition, the table also shows Sabrient’s proprietary Bull Score and Bear Score for each ETF.
High Bull score indicates that stocks within the ETF have tended recently toward relative outperformance during particularly strong market periods, while a high Bear score indicates that stocks within the ETF have tended to hold up relatively well during particularly weak market periods. Bull and Bear are backward-looking indicators of recent sentiment trend.
As a group, these three scores can be quite helpful for positioning a portfolio for a given set of anticipated market conditions.
1. Technology (IYW) and Healthcare (IYH) remain at the top of the Outlook rankings, and they are now in a virtual tie, with IYW scoring 86 and IYH 85. They are now bothl above the 80 mark, which I consider important for the top-ranked stock in order for the relative rankings to be predictive. (When the scores are bunched together at lower values, it indicates to me indecision and uncertainty about which sectors will be the leaders.) IYH has been particularly strong in maintaining analyst positive sentiment, while IYW is particularly strong in its return ratios and also sports a solid (low) projected P/E.
2. Basic Materials (IYM) is the big mover of the week, jumping 23 points to 54. It sports a low projected P/E and is getting a bit more support from the analysts, who had been downgrading earnings projections pretty aggressively.
3. Telecom (IYZ) and Consumer Services (IYC) still dwell at the bottom of the rankings. IYZ remains saddled with the highest projected P/E, while IYC is burdened by tight margins and low return on sales.
4. Looking at the Bull scores, IYM has been the clear leader on strong market days, scoring 59, followed by Financial (IYF), Industrial (IYJ), and Energy (IYE). Utilities (IDU) is by far the weakest on strong days, scoring a 31.
5. As for the Bear scores, IDU is no longer the investor favorite “safe haven” on weak market days. I think it is because volatility has mellowed so much. Recall that IDU was the top performer for 2011. The new favorite on weak days is Healthcare (IYH) with a score of 61, followed by IDU at 59. IWM, the strongest on bullish days, displays by far the lowest Bear score of 44, which means that stocks within this ETF sell off the most on weak market days. Interestingly, only three of the sector iShares (IYM, IYF, and IYE) have Bear scores below 50.
6. Overall, IYH and IYW are tied for the best combination of Outlook/Bull/Bear scores. Adding up the three scores gives a total of 188. IYZ is the worst at 118. IYJ shows the best combination of Bull/Bear with a total score of 107, while IDU has the worst combination at 90, as a more stable market has been ignoring Utility stocks.
Top ranked stocks in Technology and Healthcare include SYNNEX Corp (SNX), NetEase.com (NTES), Momenta Pharmaceuticals (MNTA), and United Therapeutics (UTHR).These scores represent the view that the Technology and Healthcare sectors may be relatively undervalued overall, while Consumer Services and Telecom sectors may be relatively overvalued based on our 1-3 month forward look.
Disclosure: Author has no positions in stocks or ETFs mentioned.