Market Begins May With A Healthy Rise

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Includes: DIA, QQQ, SPY
by: Louis Navellier

Summary

The stock market may look calm on the surface, but we're constantly seeing various sectors and stock market components churning wildly under the surface.

the recent market rise comes from short covering and a rotation into beaten-down energy and commodity-related stocks.

Aggressive stock buyback activity may explain some of the underlying strength in the stock market in recent weeks.

Through April 30, the DJIA is up 2%, the S&P is up barely 1%, and NASDAQ is down 4.6%. As Apple (NASDAQ:AAPL) proved last week, and Netflix (NASDAQ:NFLX) demonstrated in the previous week, the leadership of the stock market is changing fast. The stock market may look calm on the surface, but we're constantly seeing various sectors and stock market components churning wildly under the surface.

Last week was an incredible week for earnings surprises. The flagship stock that was talked about the most last week was Apple, which posted negative first-quarter sales and earnings growth - its first drop in revenues in 13 years.

Compounding Apple's woes, the analyst community is forecasting negative sales and earnings growth for the next two quarters and for all of 2016. Apparently, there is a push back in emerging markets about the cost of Apple's premium iPhones, which are very expensive relative to other smartphones. Even though Apple introduced a cheaper iPhone SE to boost its emerging market sales, competition for smartphones is real and operating margins are under compression. Despite the fact that Apple boosted its stock buyback program and raised its quarterly dividend, investors were rattled by the first sales decline in iPhones after an incredible nine-year run. Clearly, Wall Street wants to see positive sales growth, which Apple will likely deliver by the fourth quarter, when its long-anticipated iPhone 7 is expected to be released. (Please note: Louis Navellier does not currently hold a position in AAPL or NFLX. Navellier & Associates, Inc. does not currently hold a position in NFLX for any client portfolios. Navellier & Associates, Inc. does currently hold a position in AAPL for some client portfolios.)

Some Gems (and a Lot of Junk) Lead The Recovery

Last week (in "Smallcap Losers Surge," April 27), the folks at Bespoke Investment Group updated their decile matrix of the factors that have been driving performance since the stock market lows on February 11th. Amazingly, some of the best performers were in the extreme deciles (top 10% or bottom 10%) with traditionally negative characteristics: (1) The bottom 10% in capitalization soared 42.5%, (2) the worst 10% in 2016 performance through February 11th surged 41.33%, (3) the highest 10% in price/earnings (PE) ratios shot up 33.11%, and (4) the highest 10% in short interest surged 29.93%.

In other words, your best bet in the market surge from February 11 to April 27, 2016 was a small-cap stock with high short interest, a high P/E ratio, and a horrible start to 2016. Clearly, the recent market rise comes from short covering and a rotation into beaten-down energy and commodity-related stocks.

Based on my 38 years of monitoring the stock market, I can tell you that junk like that usually doesn't stay on top for very long. There were some bright spots in the Bespoke report, however. It also shows that the top decile of stocks with the highest dividend yields surged 28.3% since the stock market low on February 11th. (For comparison purposes, the overall S&P 500 gained 14.5% in that same time span.)

Another sector with sound fundamentals also rose 28%. Specifically, the bottom 10% of stocks with the lowest P/E ratios surged 28.3%. These two segments show us that some stocks with good underlying fundamental factors have virtually doubled the market's average gains over the last 11 weeks.

Corporate Stock Buybacks Boost EPS

So far, among the companies in the S&P 500 that have announced their first-quarter results, positive earnings surprises are running at a 74% pace, higher than the 71% pace at the same time in the fourth quarter.

Aggressive stock buyback activity may explain some of the underlying strength in the stock market in recent weeks. As long as the Federal Reserve keeps short-term interest rates ultra-low, we can expect more companies to borrow money or issue bonds at low interest rates in order to buy back more shares.

The Financial Times reported last Monday ("Stock buybacks a boon to U.S. Q1 earnings") that the proportion of stocks in the S&P 500 Index that have reduced their outstanding shares (i.e., bought back more shares) by at least 4% in the past year have risen to 30.3% for companies that have reported first-quarter earnings, up from 25.8% in the fourth quarter of 2015 and 21% in the first quarter of 2015.

Share Buy Backs Bar Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Naturally, with fewer outstanding shares, corporate buybacks help to boost earnings per share (EPS).

Today's low interest rate environment is expected to persist in the upcoming months after the central bank comments last week. Specifically, on Wednesday, the Federal Open Market Committee (FOMC) statement was incredibly dovish, since it cited a mixed economic environment due to lingering concerns over low inflation and slower growth. Interestingly, the Fed noted that household spending has slowed even though real income has risen and consumer sentiment remains relatively high. The FOMC statement sounded clueless when it said, "The (Fed) continues to closely monitor inflation indicators and global economic and financial developments." Translated from Fedspeak, the FOMC is frozen, confused, and full of trepidation, so they will probably do nothing, which may explain why the Fed left key interest rates unchanged. Speaking of apprehension, I should add that the Bank of Japan on Thursday also left its key interest rates unchanged at -0.1% and maintained its quantitative easing at an 80 trillion yen ($718 billion) per year pace. Overall, it increasingly appears that central bankers are confused, rudderless, and powerless.

Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.

Disclaimer: Please click here for important disclosures located in the "About" section of the Navellier & Associates profile that accompany this article.