In previous letters, we reviewed several changes occurring within the global financial system. Among those were the the increases in 1% volatility days, increasing interest rates, and changes in top performing sectors as the market (DIA), (SPY), and (QQQ) was testing lows at the beginning of the second quarter. There have been many crosswinds including:
- Rising Federal Funds rates to curb inflation
- Softening of select real estate markets
- Increased GDP which was last reported at a promising 3.5%
- Continued earnings growth
- Global trade and political tension
- 3.7% unemployment
- And lastly, the growing level of division we are facing as a nation.
What I find peculiarly interesting is the amount of pessimism in the face of so many positive indicators. These are usually NOT signs of a market that is topping out.
The most discouraging thing has nothing to do with stock market volatility, economic growth worries, rising interest rates or any other economic figures. My biggest concern is the hyper partisanship and division that we’re facing as a nation. Our great nation was built on the unification among people of different backgrounds and ideologies. Many of whom were brought together by hope and the pursuit of a better life. That kind of thinking may seem old fashioned when compared to the present mindset, by which so many people’s hopes and dreams are predicated on the success of one political party or another. With that said, I think we all can agree that we look forward to being past the November 6 elections. I’m fairly confident the market is.
Following up from previous letters:
- I still believe we are in a secular bull market that can possibly last another three to four years. Corrections can occur within bull markets, like crash of 1987 that occurred in the midst of one of the longest bull markets in history.
- I continue to expect more frequent 1% days where the Dow Jones Industrial Average (The Dow) can easily swing more than 250 points on any given day.
- Interest rates appear to be continuing a slow climb to higher levels. However, don’t get too excited because major peaks and troughs are often separated by as many as 50 years.
There have always been plenty of reasons NOT to invest. For example, when I began in this industry over 20 years ago, the Dow Jones Industrial Average or the Dow was wavering between 7500 and 9000. At that time Y2K was looming all over the media and investors were concerned that on January 1, 2000, all our databases would crash due to issues with how dates were recorded, which in turn could precipitate a market crash. Having evaded that impending crisis, many investors ignored fundamental concerns which were described by Alan Greenspan as “irrational exuberance” during the dotcom bubble. This bubble was inflated by exponentially high prices and historically high PE ratios in NASDAQ stocks. People seemed to realize that prices were unsupported by fundamental analysis however, more and more speculators jumped in not realizing how far it could fall. When the bubble imploded in 2000, the NASDAQ Composite Index lost nearly 80% of its value over the following two years.
The next major catastrophic event was 9/11. Despite the prolonged war on terror, the Dow managed to move to over 13,000 by 2007 however, the next crisis was right around the corner. The events leading up to the 2007 subprime lending crisis and the subsequent 2008 credit meltdown were peculiar. “Everybody knew” that borrowing money was far too easy and that housing prices were too high before the housing market crash. What they didn’t realize was how bad that 100-year storm was going to get (sound a little familiar?). The aftermath traumatized nearly every investor and property owner in the nation. Nothing felt safe not Real Estate, not the Stock Market, not the Bond Market, not even the Money Market.
It wasn’t until March 9, 2009, after reaching a gut-wrenching low of 6469.95 on the Dow, that the market did an about face. Eerily, the S&P reached a low of 666.79 that same day, which was almost 11 years after I began my career in the investment management world. I remember thinking the Dow was more than 1000 points below the 1998 low. Adding insult to injury, my house in Bradenton, FL, was worth less than what it cost to build in 2000. My resolve was certainly pushed to the limit but, fortunately I made the decision to press on.
Fast forward almost 10 years, to the present, and the Dow nearly reached 27,000. This is despite a long laundry list of obstacles:
- 2009 Chrysler/GM file bankruptcy
- 2010 BP Oil Spill
- US stocks falling 20% in 2011
- S&P downgrading US debt in 2011
- 2013 US Government shutdown
- 2014 Ebola virus concerns
- 2016 Global stock market sell-off
- 2016 Brexit
- 2017 elections
On a positive note, I wouldn’t be surprised if we see the Dow 34,000 to 36,000 over the next 4 years and 100,000 over the next 20. Those prices wouldn’t be unreasonable if the market returns an average of 6% or more per year. Anyway, it’s time to quite daydreaming and move on to sector leadership.
Consumer Discretionary (XLY)
The consumer discretionary sector (NYSEARCA:XLY): Listed below are some of the top holdings: The Home Depot, Inc. (NYSE:HD), Comcast Corporation (NASDAQ:CMCSA), McDonald's Corp. (NYSE:MCD), Starbucks Corporation (NASDAQ:SBUX), NIKE, Inc. (NYSE:NKE), Amazon.com Inc (AMZN), Walt Disney (DIS), Trip Advisor (TRIP), Lowes Companies, (LOW), Target Corp (TGT), TJX Companies Inc (TJX), General Motors (GM)
The Healthcare sector (NYSEARCA:XLV) is in favor based on relative strength. Some of the favored holdings in this sector are Pfizer Inc (PFE), United Health Group (UNH), ResMed Inc. (NYSE:RMD), Intuitive Surgical (ISRG), Merk (MRK), Amgen (AMGN), Abbott Laboratories (ABT), and Eli Lilly (LLY). Other holdings in the healthcare sector include: Bristol-Myers Squibb Company (NYSE:BMY), Mylan N.V. (NASDAQ:MYL), Johnson & Johnson (NYSE:JNJ), AbbVie Inc (ABBV), and Stryker Corporation (NYSE:SYK), and
The technology sector (NYSEARCA:XLK) is still in favor and a partial list of technology components include, Agilent Technologies Inc. (NYSE:A), Alphabet Inc. (NASDAQ:GOOG), Western Digital (WDC), Microsoft Corporation (NASDAQ:MSFT), Facebook, Inc. (NASDAQ:FB), Automatic Data Processing, Inc. (NASDAQ:ADP), Nuance Communications, Inc. (NASDAQ:NUAN), Edwards Lifesciences Corp. (NYSE:EW), Cisco Systems, Inc. (NASDAQ:CSCO), Intel (INTC), Adobe (ADBE), Oracle Corp (ORCL) and Nvidia (NVDA)
Defensive Sectors in Favor
The utilities sector (NYSEARCA:XLU) has been in favor since October. This sector generally provides dividend income opportunities and a somewhat defensive stance in volatile markets. Some of the top holdings in this sector include: NextEra Energy (NEE), Duke Energy Corporation (NYSE:DUK), American Electric Power Co., Inc. (NYSE:AEP), Southern Company (NYSE:SO), Dominion Resources, Inc. (NYSE:D), PG&E Corporation (NYSE:PCG), and Public Service Enterprise Group Inc. (NYSE:PEG
Consumer Staples (XLP)
The consumer staples sector (NYSEARCA:XLP) would likely continue to be favored if the overall markets move back into bear territory. This wouldn’t be the optimal scenario however, it’s worth noting that they have been leading over the last month. Here is a partial list of consumer staples: The Procter & Gamble Company (NYSE:PG), The Coca-Cola Company (NYSE:KO), PepsiCo (PEP), Philip Morris (PM), Altria Group (MO), Wal-Mart Stores Inc. (NYSE:WMT)
Sectors to watch
The Financial Sector (XLF) is close to returning to favor based on relative strength. Some financial sector ideas include: JPMorganChase & Co (JPM), Brown & Brown Inc. (NYSE:BRO), CME Group Inc. (NASDAQ:CME), Nasdaq, Inc. (NASDAQ:NDAQ), Oaktree Capital Group, LLC (NYSE:OAK), Wells Fargo (WFC), PNC Financial Services Group (PNC), and for a little international flavor ICICI Bank (IBN) or Banco de Chile (NYSE:BCH)
Basic Materials (XLB)
The materials sector is showing some relative strength versus the S&P 500 and is close to returning to favor. Materials exhibiting relative strength versus their sector include: The Sherwin-Williams Company (NYSE:SHW), DowDuPont Inc (DWDP), Alcoa Inc. (NYSE:AA), United States Steel Corp. (NYSE:X), Newmont Mining Corporation (NYSE:NEM), The Scotts Miracle-Gro Company (NYSE:SMG), Ecolab Inc (ECL), Air Produts (APD), Freeport-McMoRan Inc (FCX), International Paper (IP), and Nucor Corp (NUE).
Dow Jones Transportation Average (XTN)
The transportation sector fell out of favor in October however, there has been some recent strength. A partial list of equities in the transportation sector include, XPO Logistics Inc (XPO), Kirby Corp (KEX), Knight-Swift Transportation Holdings Inc A (KNX), Hertz Global Holdings Inc (HTZ), Old Dominion Freight Lines Inc (ODFL), Avis Budget Group Inc (CAR), FedEx Corp (FDX), JB Hunt Transport Services Inc (JBHT), Allegiant Travel Co (ALGT), Norfolk Southern Corp (NSC)
Mid Cap (NYSEARCA:MDY)
Some of the holdings include: Dominos Pizza (DPZ), Take-Two Interactive Software Inc (TTWO), NVR Inc (NVR), MSCI Inc (MSCI), Teleflex Inc (TFX), Broadridge Financial Solutions Inc (BR) Cognex Corp (CGNX) Steel Dynamics Inc (STLD), Trimble Inc (TRMB), IDEX Corp (IEX), Old Dominion Freight Lines (ODFL)
Small Cap (NYSEARCA:SLY)
A partial list of holdings include: CACI International Inc Class A (CACI), Chemed Corp (CHE) Healthcare Services Group Inc (HCSG), On Assignment Inc (ASGN), Five Below Inc (FIVE), Marriott Vacations Worldwide Corp (VAC), Insperity Inc (NSP), Ingevity Corp (NGVT), Green Dot Corp (GDOT),
Emerging Markets (NYSEARCA:EEM)
The emerging markets have been increasing in relative strength more recently. Some of the holdings are Tencent Holdings Ltd, Alibaba Group Holding Ltd ADR (BABA), Samsung Electronics, Taiwan Semiconductor (TSM), Baidu Inc Adr (BIDU). Many investors may consider (EEM),
The industrial sector (NYSEARCA:XLI) and some of the components include: Boeing Co (BA), 3M Co (NYSE:MMM), Honeywell International Inc (HON), Union Pacific Corp (UNP), United Technologies Corp (UTX), Caterpillar Inc (CAT), Lockheed Martin Corp (LMT).
A partial list of energy sector components include, NRG Energy, Inc. (NYSE:NRG), Schlumberger Limited (NYSE:SLB), Exxon Mobil Corporation (NYSE:XOM), Halliburton Company (NYSE:HAL), Concho Resources, Inc. (NYSE:CXO) are trading positively when compared to the S&P 500 index.
Despite all the doom and gloom, my proprietary risk meter continues to suggest opportunity for investors looking for a lower risk entry point into leading sectors and equities. Since the end of September, a considerable amount of risk has been released from the market and we are now in territory where historically, investors have often been rewarded. On April 2, 2018, the Dow successfully tested the low with a confirmation a few days later. Despite the absence of a clearly defined V shape or W shaped bottom, we have encountered a series of higher highs and higher lows since the April 2018 low of 23,334. I am optimistic about this trend and believe that active investors and those with cash to invest can begin buying the dips. The caveat for this to be successful is the Dow needs to remain above the April low. On a historical basis, brief intraday violations of the lows, coupled by a strong intraday bounce and 2 to 3 days follow through have also been known to successfully occur. Please look at previous letters for a detailed explanation of market low confirmations.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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