Stocks Are Recovering Unevenly - In A 'Washing Machine' Cycle

Includes: SPY
by: Louis Navellier

The S&P 500 rose almost 2% last week, while the Dow Industrials rose over 3%. The biggest gains came early in the week when the world seemed to have avoided any escalation of war over the use of chemical weapons in Syria. Hidden underneath these rising market averages, however, I'm seeing a bizarre rotation among stock sectors and an unreasonable rise in some of the board's worst stocks. I call this the "washing machine" market cycle, and it will likely continue until earnings season begins.

Stocks and Sectors are Stuck in a "Washing Machine Cycle"

On the surface, the stock market looks firm, but under the surface it is churning. For example, Apple (NASDAQ:AAPL) rallied early last week, leading up to its new iPhone announcement Tuesday night. Then, Apple lost its "mojo" immediately after the announcement. The stock gapped down $25 (-5%) Wednesday morning.

I believe we will remain in this "washing machine" type of market - with a lot of stocks sloshing back and forth - until third-quarter earnings announcement season begins early next month.

Here are some examples of the market "agitation" we have witnessed since May 1:

  • High dividend stocks as an overall sector were hot through April 30, but many turned cold when interest rates rose.
  • As a group, homebuilding stocks were cold through May 14, but many have bounced back dramatically since then.
  • Home improvement and appliance stocks as a group were hot through May 14, but many have since cooled off.

Putting those trends together, since May 14, many homebuilders have rallied, despite poor earnings guidance, due in part to higher mortgage interest rates, while many home improvement and appliance companies have cooled off, despite rising earnings from Lowe's (NYSE:LOW) and Home Depot (NYSE:HD). That doesn't make a whole lot of sense, but it all goes back to that I believe we are in a washing machine cycle where stocks, aided by high-frequency trading systems, slosh around without any seeming relevance to their underlying fundamentals.

More recently, since August 27, when the S&P 500 hit a near-term low, most of the stocks that have done the best are at the extreme 10% in various fundamental categories we follow. They typically are: (1) the bottom 10% in terms of market capitalization, (2) the top 10% in highest price/earnings ratios, (3) the bottom 10% in terms of dividend yields, and (4) the highest 10% in terms of short interest. In other words, low-priced, low quality names have been leading the way since August 27, as the "shorts" have been getting squeezed.

I anticipate this sloshing back and forth will last until Wall Street refocuses on the upcoming third quarter sales and earnings announcement season, which will reward stocks with stronger fundamentals.

Stocks Rise - and Commodities Fall - as War Fever Subsides

The market's overall churning - up and down, back and forth - is also due to the rise and fall of war fever in Syria. In the first two weeks of September, President Obama first sought Congressional authorization to attack Syria, but then he postponed this request due to Russian President Vladimir Putin brokering a deal for Syria to turn over its chemical weapons. But then, Putin almost simultaneously offered to supply Iran with sophisticated air defense systems, as well as a second reactor at Iran's Bushehr nuclear plant.

My research associate Ivan Martchev caused quite a conversation in his MarketWatch posting last Friday titled "Could Syria be About Oil?" He explained why he believes Russia is so involved in current Syrian negotiations. Russia is protecting its allies in the region. When you look at a map of Syria, Ivan explains, the only way for vast amounts of oil and natural gas from Saudi Arabia, UAE, and Qatar to move through pipelines toward Turkey (which is short on such deposits), and later on toward Europe - is through Syria.

Sure enough, crude oil prices reached an annual high on September 6, at the peak of Syrian war fever, but they have since settled down. Gold soared over $1400 in early September (from a low of $1192 in late June) on war fever, but gold has since fallen to a five-week low of $1308 on Friday as war fever subsided.

Gold also fell last week as the majority of Fed watchers concluded that the Fed will likely announce the beginning of "tapering" at its FOMC meeting this week, but I still have a sneaking hunch that the Fed will see the seemingly positive outcome of the massive monetary easing in Japan and decide to postpone tapering.

Japan's second-quarter GDP rose at a 3.8% rate, up from an initial 2.6% estimate. This is the kind of GDP growth the Fed wants to see. In addition, current economic statistics are "mixed" (negative and positive), so the Fed might not want to gamble on prematurely tapering its level of quantitative easing this week.

Stat of the Week: August's $148 Billion Budget Deficit Caused No Increase in Debt

In August, the federal government's budget deficit increased by $148 billion, but miraculously the total public debt did not increase at all. Despite the $333 billion in federal outlays vs. just $185 billion in taxes received, the rise in the public debt was $0. This is because of the "extraordinary measures" Treasury Secretary Jacob Lew is taking to avoid going over the mandated debt ceiling. But his time is running out.

The good news is that the federal government remains on track for its first sub-trillion dollar deficit since 2008. The government's fiscal year ends in two weeks, on September 30. After August's $148 billion deficit, the federal government's total 11-month deficit is $755 billion, down 35% compared to the same period a year ago. Thanks to 13% higher tax revenues and a 4% spending decline from the sequester mandate, plus significantly lower military spending, the federal government is going broke more slowly.

In the wake of President Obama asking for and then postponing his war authorization request, Congress is suddenly more respectful of the executive branch, so I expect the impending debt ceiling debate will be resolved. Most of the debate will likely center on the mandatory sequester cuts in spending, but in the end, I expect those sequester cuts will continue and the budget deficit ceiling will be raised in time.

The other economic news last week was mixed. On Friday, the Commerce Department announced that retail sales rose 0.2% in August - well below economists' consensus estimate of a 0.5% increase. The good news in that report is that July's retail sales were revised to 0.4%, up from the 0.2% first reported. Overall, retail sales have risen 4.7% in the past 12 months - not bad, but the growth rate is decelerating.

Speaking of cautious consumers, the University of Michigan and Reuters reported that their preliminary reading of September's consumer sentiment declined to 76.8, a five-month low, vs. 82.1 in August.

Finally, on Friday, the Department of Labor said the Producer Price Index (PPI) rose 0.3% in August, a notch above economists' consensus estimate of 0.2%. Excluding food and energy, which surged 0.7% in August, the core PPI was unchanged. A 27% surge in vegetable prices led the surprising surge in food prices in August. In the past 12 months, the PPI has risen 1.4% and the core PPI, excluding food and energy, has risen only 1.1%, so wholesale prices remain relatively well behaved, despite the recent surge.

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Disclosure: I am long AAPL, HD, LOW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.