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Chaikin Market Insights - April 5, 2014


Chaikin Market Insights - April 5, 2014

What a Difference a Day Makes

The S&P 500 Index closed at 1,865.09, up 0.4 % on the week. The stock market finally broke out above 1,876 on Tuesday's close and then banged up against our long-standing target of 1,900 on Friday. The initial response to the non-farm payroll report was positive but the market broke down at 10:45 led by weakness in the Biotech and Technology sectors. This weakness gathered momentum as the day wore on, spilling over to the broad market.

The S&P 500 finished down 1.25% on the day and the Nasdaq finished off 2.5%, its worst day in almost 3 years. As we pointed out last week, "There has been a rapid shift away from growth stocks in general and Biotech and Internet related stocks specifically. This has put pressure on the Nasdaq 100 Index as well as the Russell 2000 small cap Index. The S&P 500 Index and the Dow Jones Industrial Average have held up rather well."

Market declines which are triggered by bad news or headline events are relatively easy to deal with, as the impact is usually short-lived. I am always leery, however, of market declines which come without any visible impetus. This is the case with the current waterfall declines we are seeing in the high growth/high momentum stocks which have been taken to the cleaners in the past 2 weeks.

Group rotation in the stock market is usually more subtle than what we have just witnessed. As the market has moved abruptly away from the growth stocks which led us to new highs, and taken refuge in the stodgier names like Microsoft, Intel and Merck, there has been a shift in character which makes me uneasy.

It is too early to tell whether this is a sector rotation which the market will gracefully absorb and then move on to new highs, or whether it will indeed lead to the long talked about correction of 10%. The economic statistics don't suggest an economy which is slowing down and Europe is on the upswing, both in its economy and its stock markets.

Much will depend on the company guidance which accompanies the 1st quarter earnings reports which start to trickle in this week. It seems from the non-farm payroll numbers that the economy has started to pick up after the harsh winter related slowdown. There has been widespread speculation that earnings may be soft in these 1st quarter reports, with companies using the weather as an excuse. This also leaves them the latitude to guide higher for the 2nd quarter and the full year 2014.

So company guidance, in my opinion, is the key to the market's ability to withstand any spillover from the cascade of selling in high momentum stocks. Take a more cautious view of rallies from here, particularly if the market regroups and tests the 1,900 level 1 or 2 more times.

Where Are We Headed And How Will We Get There?

The stock market is bifurcated right now … growth stocks have been breaking down under intense selling pressure while stocks sensitive to the state of economic conditions have led the charge to new highs. We were very vocal about avoiding the high P/E, high price to sales stocks which have taken it on the chin in recent weeks (although we did not see the weakness in Biotech coming). Continue to avoid high or no P/E stocks with bearish Power gauge ratings like Amazon (NASDAQ:AMZN), Facebook (NASDAQ:FB), LinkedIn (LNKD), Pandora (NYSE:P), Rackspace (NYSE:RAX), Trulia (TRLA), Yelp (NYSE:YELP) and Zillow (NASDAQ:Z). These stocks plus new issues in the software area like FireEye (NASDAQ:FEYE), Splunk (NASDAQ:SPLK), Workday (NYSE:WDAY), ServiceNow (NYSE:NOW), and Tableau Software (NYSE:DATA) are still vulnerable, have terrible chart patterns and should be sold on rallies.

The market is a tug of war right now between fundamentalists who see an improving economy both here and abroad as a positive, which will cushion any further declines, and the alarmists who see parallels between the 2000 tech bubble, the 2008 financial bubble and today's collapse in momentum stocks.

It is well to note that in the decline of 2000-2002 the value stocks were actually up while tech stocks were dropping 90%. I think it is too early to tell who will be right, but a few observations about timing and technical may help.

We expected a top around 1,900 in mid-April and a correction of between 5-10%. That fit historical patterns and the choppy, volatile 1st quarter market action. We have no reason to change that view. The market closed Friday right at support on the S&P 500 Index at 1,865. If this holds early next week then another attempt to breakthrough 1,900 will develop. Use this rally to lighten up positions.

If on the other hand support breaks next week, to head down to 1,820 and possibly 1,728 - 1,768, this would be a worst case correction scenario … but one that should not be ignored.

Defensive stocks like Electric Utilities and large Drug stocks will perform better in this type of decline. Telecoms and stocks like Caterpillar (NYSE:CAT) will also do relatively well in a market decline. We also see strength in specialty Semiconductors like Freescale (NYSE:FSL), Nvidia (NASDAQ:NVDA) and ON Semiconductor (ONNN) as indicators of an improving economy worldwide.

Weekly Sector and Select SPDR ETF Update

Strength continued last week in the Utility ETF, (NYSEARCA:XLU), until weakness on Friday in the 5 year treasury pushed those yields up versus 30 year treasury bonds, and in the Select SPDR Energy ETF, (NYSEARCA:XLE).

2014 Model Portfolio Quarterly Update

The Chaikin 2014 Model Portfolio finished the 1st quarter up 0.59% vs. a gain of 1.3% for the S&P 500 Index. Its orientation away from high momentum growth stocks and toward companies giving cash back to shareholders in the form of dividend increases and buybacks has enabled the portfolio to track the market rather closely. The biggest loser has been iGATE (NASDAQ:IGTE) the Indian software and consulting company which guided lower in January. They report later this week and the hope is slightly better guidance will lift this stock.

The biggest winners have been Avnet (NYSE:AVT), Brocade (NASDAQ:BRCD), Legg Mason (NYSE:LM), Phillips 66 (NYSE:PSX), Reinsurance Group (NYSE:RGA), Olin Corp (NYSE:OLN) and Ryder Systems (NYSE:R). All of these stocks made new highs with the market this past week and are candidates for purchase on pullbacks of 3 - 8 days.