You knew a bigger pullback would happen eventually. It was only a matter of when it would come, what would be the catalyst, and how far it would fall. In fact, investors have been hoping for a pullback to serve as an entry point to put more cash to work.
As I have been noting, the recent underperformance of quality-oriented quantitative models has shown all the signs of a “junk rally” phase that generally precedes a significant pullback. But it should remain contained. Optimism for U.S. stocks continues to improve as bears struggle to get any downside traction…and of course the liquidity spigot is still open.
Sure, the domestic economic data has been mixed and often disappointing, and yes, Spain appears to be struggling worse than hoped as the European debt contagion continues into the unknown. But it all seems to have merely provided an excuse for the overdue technical pullback. Wednesday’s bounce after Tuesday’s elevated-volume selloff is certainly promising. Alcoa’s (NYSE:AA) positive earnings report helped bolster conviction.
On Tuesday, the major indexes were back below round-number resistance-turned-support levels at 13,000 on the Dow, 3000 on the Nasdaq, and 1400 on the S&P 500, but the Nasdaq recaptured 3000 on Wednesday, and the S&P 500 bounced back near prior resistance-turned-support at 1370. Looking at the SPY chart, it closed Wednesday at 137.00, which is below its near-term uptrend line (since late December) and very close to its longer-term uptrend line.
SPY is now trying to claw its way back above the 50-day simple moving average. A failure here might take it down to test its 100-day. However, RSI and Slow Stochastic have worked off overbought conditions, while MACD has made good progress in doing so. So, this is probably a spot where buyers will test bullish conviction by putting some cash back to work.
The VIX (CBOE Market Volatility Index—a.k.a. “fear gauge”) closed Wednesday at 20.02—essentially right at the important 20 threshold. 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) closed Wednesday at 38 bps, which is right around the 40 level that it has settled at.
I still believe that unless the bottom falls out on high volume (likely due to a major external event), taking out important support levels, “buy the dip” will remain the working mantra.
Latest rankings: The table ranks each of the ten U.S. industrial sector iShares (ETFs) by our 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 our 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. As we head into earnings season, Technology (NYSEARCA:IYW) remains at the top of the Outlook rankings with an 80, but Financial (NYSEARCA:IYF) has pulled into a tie. IYW is particularly strong in its return ratios as margins remain high in tech products, but it is strong pretty much across the board on all relevant factors. IYF continues to gain strong support among analysts, along with Consumer Services (NYSEARCA:IYC), and its projected P/E is still relatively low.
3. Telecom (NYSEARCA:IYZ) remains at the bottom of the rankings with a 2. IYZ is saddled with the worst return ratios and the highest projected P/E. It is again joined in the bottom two by Utilities (NYSEARCA:IDU) with a score of 21. IDU has low long-term growth projections and a relatively high projected P/E.
5. As for the Bear scores, IDU is the investor favorite “safe haven” on weak market days, scoring 67, followed by IYK at 64. Notably, IYF continues to strengthen on this metric. IYM shows the lowest Bear score of 40. This means that Basic Materials stocks tend to sell off the most when the market is pulling back.
6. Overall, IYF now shows by far the best combination of Outlook/Bull/Bear scores. Adding up the three scores gives a total of 190. IYW is close behind at 186. IYZ is by far the worst at 103. IYF also shows the best combination of Bull/Bear with a total score of 110. IYE and IYM share the worst combination with a 94.
These scores represent the view that the Technology and Financial sectors may be relatively undervalued overall, while Utilities 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.