After an almost straight-up run for the first three quarters of the year, stocks are no longer making it quite so easy of a decision to stay long. Nevertheless, the bulls seem to be holding strong in their conviction. Apple (AAPL) has been a leader throughout, but even during that recent 5-day stretch when money was pulling out of Apple, it hasn't necessarily gone to cash-it's just shifting to other sectors, including cyclicals like Caterpillar (CAT). Moreover, the Dow Jones Transportation Average has been strong.
This continues to suggest to me that the downside is limited - so long as the Bernanke-driven supply of free money continues. As a reminder, although there is currently no quantitative easing program in place, the Fed launched "Operation Twist" last October whereby it sells $400 billion in short-term Treasuries in exchange for the same amount of longer-term bonds in an effort to depress yields on longer-term bonds (while maintaining ultra-low short-term rates) with the intent of incentivizing consumer and business to borrow and spend by pushing down interest rates on loans and mortgages.
This program is scheduled to end in June 2012. Because all stock market gains since the March 2009 V-bottom have occurred during Fed stimulus programs, it is quite possible that the market will stall or even selloff in June when Operation Twist ends. But for now, the stage is set for further gains.
Individual and institutional investors as well as corporations are all still sitting on historically high reserves of cash. As fear stays low, the cash has been finding its way into the markets, including corporate stock buybacks and acquisitions.
Earnings season kicked off last week, and so far the number of companies beating earnings estimates and giving positive guidance has been quite high. For example, Seagate Technology (STX) - Sabrient's top pick in its "Baker's Dozen" top stocks for 2012 - just gave a fine report, and Wednesday it hit a new 9-year high and finished the day up nearly 4%.
Reported revenues are harder to manipulate than earnings, but the year-over-year consensus estimates on top-line growth are not very challenging as analysts have been quite conservative. So, I expect more good news this season.
That leaves European sovereign debt issues and growth concerns in China as the main things that could derail the bull train.
As for Europe, it is now Spain that has emerged front and center, so when Spanish bond rates rise, the markets get more fearful. Since early March, the 10-year yield has risen from 5.0% to 6.0%-with 6% seemingly the dividing line between manageable and unmanageable debt payments. On Monday, the yield rose above 6% and stock markets sold off. On Tuesday, yields fell and markets rose spectacularly. (For comparison, U.S. 10-year notes yield about 2% and Germany is near 1.7%.)
Still, although the ECB has kept the liquidity spigot open to Spain's advantage, many observers believe that there is no avoiding an eventual bailout of Spanish banks, and they say that Italy (with a GDP 50% larger than Spain's) will be close behind. No doubt, Germany has benefited from the EU in that the weaker economies can't devalue their currencies against the Deutschmark like they used to, since they all use the euro now. But the flipside is that Germany is responsible for supporting the bailout of their EU brethren.
As for China, last week the country reported weaker year-over-year GDP growth of only 8.1%-down but still quite robust. Of course, the Chinese government will do everything in its power to avoid a hard landing scenario, but also with a measured effort to prevent it from overheating. Perhaps the biggest threat in this regard is a potential real estate bubble.
Of note, China is the subject of this month's edition of The MacroReport, which is a monthly co-publication of Sabrient Systems and MacroRisk Analytics, providing an in-depth analysis of the macroeconomic trends in focus territories. The MacroReport offers a unique combination of global market commentary and analysis with specific actionable ideas. The new issue considers three scenarios driven by a combination of circumstances and events in China, and concludes with a series of economic factor-based ETF portfolios and "Quick Response" stock choices intended to capitalize on each scenario. It will be posted on Sabrient's web site on Monday.
In addition, The MacroReport will introduce this month a valuable interactive component that is available to all subscribers. MacroReport InterActive provides a "Quick Response" to major economic shifts on a daily basis and gives access to the most current revisions and adjustments made to its optimized ETF and stock portfolios.
SPY closed Wednesday at 138.61. It is holding on to the 50-day simple moving average and the longer-term uptrend line (which I have drawn slightly different from previous weeks). A failure here might take it down to test its 100-day MA. However, RSI, MACD, and Slow Stochastic have all turned back up after cycling down (as oscillators are supposed to do).
This pattern of rising peaks and troughs is a key trait of an uptrend. I still believe that any significant pullback would be a major buying opportunity.
The VIX (CBOE Market Volatility Index-a.k.a. "fear gauge") closed Wednesday at 18.64, after recently testing resistance 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 40 bps, where is has flat-lined since mid-February. Both readings are positive for stock bulls.
Both the European Central Bank and the U.S. Federal Reserve have the ability to prevent a run on banks by ramping up their printing presses whenever necessary. Such a policy is ultimately inflationary, driving up asset values-and the main beneficiary likely would be the Financial sector.
As property values rise, the real estate market recovers, loans perform, and bank equity rises. As inflation increases and bonds sell off, long-term interest rates rise. Couple this with the Fed's ultra-low short-term rate policy (i.e., banks' cost to borrow), and it points to improving margins for banks. As we've seen in Sabrient's SectorCast quantitative model, the Financial sector has been rising up the rankings-and in fact, this week it tops the list.
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. Financial (IYF) has emerged at the top of the Outlook rankings with an 82, with Technology (IYW) holding its own in second place with a 77. IYW is still 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. Its score has been dropping lately as analysts have back off on upgrading earnings estimates. Instead, IYF has garnered the most support among analysts as the banks continue their Phoenix-like rise.
3. Telecom (IYZ) remains at the bottom of the rankings with a 2 Outlook score. It is saddled with the worst return ratios, ongoing analyst downgrades, and the highest forward P/E. It is again joined in the bottom two by Utilities (IDU) with an Outlook score of 19. IDU has low long-term growth projections and a high forward P/E.
4. Looking at the Bull scores, Financial (IYF) and Materials (IYM) have been the leaders on strong market days, scoring 57, followed closely by Industrial (IYJ). Utilities (IDU) is by far the weakest on strong days, scoring 32.
5. Looking at the Bear scores, Utilities (IDU) remains the investor favorite "safe haven" on weak market days, scoring an impressive 69, followed by Consumer Goods (IYK) at 66. Materials (IYM) shows the lowest Bear score of 39, followed by Energy (IYE) at 44, indicating that Materials and Energy stocks have tended to sell off the most when the market is pulling back.
6. Overall, IYF still shows the best combination of Outlook/Bull/Bear scores. Adding up the three scores gives a total of 191. IYW is next at 182. IYZ is by far the worst at 103. IYF and IYK show the best combination of Bull/Bear with a total score of 109, followed closely by Consumer Services (IYC). Energy (IYE) now displays the worst combination with a 91, as investors appear to be shunning the sector under all market conditions. (Note: Not so long ago, investors were doing the opposite-i.e., they were sticking with Energy stocks under all market conditions.)
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.