Headlines Continue To Control Market Direction As Valuation Models Languish

Headlines continue to dominate the trading landscape, perpetuating a news-driven trader’s market rather than allowing a healthier valuation-driven investor’s market to return to favor. After all, that’s what stock market investing is supposed to be about. Narrow market breadth and daily stock price gyrations have been driven primarily by three headline generators — oil price, the Fed’s monetary policy, and China growth. Sure, there were many other important news items, notably the sinister course of Islamic terrorism. But it was those three main subjects that have been the persistent drivers of the daily buffeting of investor sentiment, and by extension stock prices.

In particular, the fact that the Federal Reserve can’t seem to remove itself from the headlines has been a disappointment. In December, it tried to fade to the backdrop by clearing up some uncertainty about its intentions by making an initial rate hike and then laying out a convincing timeline (albeit data-dependent) for a path toward normalization. But alas market speculation continues given the stark divergence between the Fed monetary policy and all other central banks. Nevertheless, it is likely that all three headline-grabbers (oil, Fed, China) may resolve much of their uncertainty over the course of the year, thus enticing investors to return to a “flight to quality” strategy.

In this weekly update, I give my view of the current market environment, offer a technical analysis of the S&P 500 chart, review our weekly fundamentals-based SectorCast rankings of the ten U.S. business sectors, and then offer up some actionable trading ideas, including a sector rotation strategy using ETFs and an enhanced version using top-ranked stocks from the top-ranked sectors.

Market overview:

Friday was a tough day due to renewed speculation about future Federal Reserve rate hikes, after the BLS reported that the U.S. economy added 151,000 jobs in January. This was below the expected 180,000 jobs, but wage inflation continued to growth, rising by 0.5%, and the workforce participation rate ticked a bit higher (although it is still near a 40-year low). For the week, the U.S. dollar fell hard against a basket of currencies and was down 1.9%. Then the selloff in equities continued on Monday, with stocks falling hard on high volume before recovering about half their losses by the close. The S&P 500 finished down 1.4% while a flight to safety pushed the 10-year yield down to 1.76% — a 12-month low. Two-year yields closed near 0.67%.

Last month was the worst January for stocks since 2009, and the start of February has led to more of the same, as bulls are getting an extreme test of conviction, with critical technical support lines trying to hold. Financials in particular seem to be inordinately bearing the brunt of the fear-driven selling. The sector was already displaying the lowest forward P/E as investors evidently doubt the accuracy of consensus earnings estimates, but it continues to take direct hits. Certainly rising credit spreads in Energy sector and Emerging Market debt instruments are a concern, as is the flattening yield curve, which makes lending less lucrative. Although we all recall that the V-bottom in March 2009 launched a 6-year bull market, most investors and commentators are not expecting the same thing this time around. Equity prices have been tied to headlines generated primarily by oil prices, the Fed, and China.

Oil price declined last week and has been struggling to hold the $30 level, which has been putting pressure on Energy and Financial sectors. As a result, oil analysts and market commentators have become progressively gloomier about the near term outlook for prices, with some price targets to the downside ranging as low as $7 to $20, and some are seeing no end in sight to the supply glut — with predictions of a calamitous fallout in oil-exporting countries and in our own domestic oil patch (and by extension, the high yield debt market).

I worked in the oil industry for the first 18 years of my career, and I must admit that I was a believer in the “peak oil” theory in which global demand would soon outstrip an ever-dwindling supply of recoverable reserves, thus driving the U.S. to ultimately import 100% of its crude oil and force us into alternative energy sources, including nuclear. The theory suggested that shale oil and other tight formations wouldn’t be economically viable until prices reached at least $200/bbl.