Last week I noted that there wasn’t much new to say about the stock market and its drivers lately, but like washing your car tends to attract rain, my comments were immediately followed by anger-driven election results in France and Greece. Both of these elections were about a rejection of austerity mandates placed upon a citizenry already feeling severe pain. The thought process is, “If the U.S. can simply print money and spend its way out of trouble, why can’t we?”
Of course, when an economy is thriving, the broad electorate is employed and happy with capitalism and free markets with a dream of potential riches. But when things are hard and austerity looms, the masses at the lowest rungs of the economic ladder suffer the most, lose faith in the system, and begin to demand Socialist policies to guarantee their well being. Class warfare ensues, and politicians who are willing to champion the plight of the vast working class often get elected. Their challenge is finding a way to actually fulfill the Herculean expectations they create.
It comes as little surprise that Greece has chosen this path. But it is somewhat of a surprise to see that this is also the path that mighty France has chosen…again.
Like Francois Mitterand 31 years ago, Francois Hollande was elected on a Socialist platform during hard financial times. He was able to oust Sarkozy by pledging to tax the rich and “reorient Europe towards employment and growth,” thus saving his countrymen from the draconian austerity measures that had been thrust upon them (by Germany). Many experts think that Hollande will not have the ability to change the course of austerity as he promised, which undoubtedly will disappoint the electorate.
The other thing that occurs during times of hardship is a bold emergence in popularity of the fringe elements. In Greece, we see both the Socialist left as well as the militant, anti-immigrant right gaining strength. Yes, while prosperity brings out the best in us like compassion, generosity, and inclusion, distress can bring out the worst in us like distrust, selfishness, militancy, and exclusion. In times like these, many voters flock to the extreme and show little patience for moderates and compromisers. Witness this week’s ouster of long-sitting Indiana senator Dick Lugar. Being known as “Obama’s favorite Republican” didn’t sell well this time.
Looking at our stock market, I see relative weakness in bull-market leaders like financials, semiconductors, commodities, small caps, and emerging markets, as the “risk-on” trade gets peeled back in a hurry. Although there has been ongoing in uncertainty in Europe, it had reached a sort of steady-state with which investors had become accustomed. The latest news was a bit of a shock, so the knee-jerk reaction to a surprise news event is to protect capital.
Nevertheless, even with the bears clawing at the door, the cards remain stacked in favor of the bulls. The equity risk premium is still quite high on a historical basis. Corporate earnings season has been strong as over 67% have beaten analyst consensus estimates. U.S. companies carry strong balance sheets with plenty of cash, and they still trade at historically low valuations. The Fed’s accommodative and ultra-low interest rate policies give a pretty big advantage to equities among competing asset classes. And policy-makers in Europe will likely remain as flexible and accommodative as they have been so far.
Of course, the almighty consumer must participate to keep the U.S. recovery in gear. Last week, unemployment data disappointed investors. CNBC’s Rick Santelli gave another one of his forceful live commentaries that made its rounds on the Internet, talking about the media’s complacency in “Ostrich Economics,” whereby they look only at a number like 8.1% unemployment and conclude that things are improving. However, Rick pointed out that the lowest labor participation rate since 1981 has created 80% of the drop in the unemployment rate. The job situation simply must start showing real improvement.
Nevertheless, no matter what the doomsayers suggest, “Don’t fight the Fed” should trump “Sell in May and go away” in the battle of the Wall Street aphorisms. U.S. investors crave more than what bonds, real estate, and gold can offer them right now, so I expect a return to stocks as the smoke from across the pond clears a bit.
SPY closed Wednesday at 135.74. It has lost that strong support it had been enjoying at the convergence of its 50-day simple moving average and the uptrend line. Global events changed the technical picture on a dime…and on some of the highest volume of the year. RSI, MACD, and Slow Stochastic were looking bullish just last week, and now Slow Stochastic is suddenly oversold. SPY is now desperately support at the convergence of the lower Bollinger Band, the 100-day simple moving average, and the line of prior support around 135.
The VIX (CBOE Market Volatility Index—a.k.a. “fear gauge”) closed Wednesday at 20.08. Last fall in the heat of the Eurozone crisis, fear was elevated and 30 was acting as strong support. As fears subsided, VIX finally broke down and it quickly made its way to test support at 20 for about 4 weeks before breaking down further. It got as low as 13.66 during March, but as the market has entered this consolidation period, VIX has been testing support-turned-resistance at 20 a few times. It is now doing so again.
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. After complacently sitting in the teens last year, it rose to near 60 at the height of the eurozone crisis in December, but has since flatlined in a this mid-level zone around 40 since mid-February.
Despite the overall strength in earnings reports this season, many companies with negative ratings on Gradient Analytics’ active coverage list have been the ones to fall the hardest lately. This includes names like Accretive Health (AH), Diodes (DIOD), Fossil (FOSL), Discovery Communications (DISCA), International Rectifier (IRF), and Mettler Toledo (MTD). Afterhours on Wednesday, Universal Display (PANL) reported and immediately sold off.
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) stays at the top of the Outlook rankings with an 82, and Technology (IYW) continues in second place with a 72. Industrial (IYJ) and Healthcare (IYH) round out the top four. IYF still has one of the lowest (best) forward P/Es, and it continues to gain support among analysts as the banks re-emerge, despite their vulnerability to Europe’s turmoil. IYW remains strong in its return ratios as margins are high for tech products.
2. Energy (IYE) and Materials (IYM) were further hammered by analyst downgrades of earnings estimates, yet they still reflect the lowest (best) forward P/Es. Consumer Services (IYC) jumped ahead of IYM this week.
3. Telecom (IYZ) remains at the bottom of the rankings with a dismal Outlook score of 5. It is saddled with the worst return ratios and the highest forward P/E. It is again joined in the bottom two by Utilities (IDU) with an Outlook score of 10. IDU has low long-term growth projections and a high forward P/E, as well as renewed earnings downgrades among Wall Street analysts.
4. Looking at the Bull scores, Financial (IYF) and Basic Materials (IYM) are the leaders on strong market days, followed by Industrial (IYJ) and Energy (IYE). Utilities (IDU) is by far the weakest on strong days, scoring 40.
5. Looking at the Bear scores, Utilities (IDU) remains the investor favorite “safe haven” on weak market days, scoring a strong 67, followed by Consumer Goods (IYK) and Healthcare (IYH). Materials (IYM) and Energy (IYE) have the lowest Bear scores, as they have tended to sell off the most when the market is pulling back. Notably, their bullish trend of higher Bear scores seems to have taken a pause.
6. Overall, IYF still shows the best all-weather combination of Outlook/Bull/Bear scores. Adding up the three scores gives a total of 193. IYW is next at 177. IYZ is the worst at 110. IYK now shows the best combination of Bull/Bear with a total score of 112, followed closely by IYF. Energy (IYE) displays the worst combination with a 100, as investors have avoided the sector under all market conditions.
These scores represent the view that the Financial and Technology sectors may be relatively undervalued overall, while Telecom and Utilities sectors may be relatively overvalued based on our 1-3 month forward look.
Disclosure: Author has no positions in stocks or ETFs mentioned.