This year, the S&P 500 has greatly underperformed its average 18% return that it historically provides during the third year of a Presidential election cycle. But then, a lot seems to be different this year as correlations across most asset classes are high and prices are buffeted more by news events than fundamentals (which has made stock picking quite challenging). Nevertheless, dovish policies by central banks around the globe have become the main drivers for improving bullish conviction, and now with a strong technical picture bolstered by solid earnings reports from market bellwethers, positive seasonality, and improving market internals, the near-term path of least resistance appears to be to the upside.
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:
On Thursday-Friday last week, the major averages were quite strong, with the Dow Industrials surging 578 points. On Friday, Technology and Healthcare were the clear winners. The biotech segment in particular tried to do some catching up for recent underperformance (and many Sabrient favorites in the space are selling at highly compelling valuations). Both sectors gapped up strongly, as did the NASDAQ 100 Index, which is largely made of stocks from these two sectors. Solid earnings reports from bellwethers like Amazon.com (AMZN), Alphabet (GOOGL), and Microsoft (MSFT) inspired the bulls to an extent, but the real driver on Thursday-Friday was the central banks in Europe and China.
ECB President Mario Draghi offered up renewed dovish sentiment by leaving interest rates unchanged, suggesting that both growth and inflation were facing downside risks, and indicating that December will be a time to re-examine current policies. Investors interpreted this to mean that the ECB will likely implement more QE in December. In addition, China’s central bank cut the cost of borrowing by 25 bps.
Despite high levels of existing debt around the globe, central banks are now encouraging higher indebtedness as a path to growth — in the hope that prosperity ultimately may lead to debts being paid down — rather than austerity, which has worked for some countries (notably Ireland) but not so much for others (notably Greece) and tends to be widely reviled.
Many economists believe that China cannot remain competitive if it does not significantly devalue the renminbi — especially when you consider that the Japanese yen has fallen 35% against the renminbi over the past three years – but the only viable approach to doing so is a slow and gradual currency depreciation that spurs economic growth in China and emerging markets.
Lately, investors here in the U.S. are facing a Twilight Zone of sorts in which everything revolves around the magic 2%. To wit, the 10-year Treasury yield is languishing at 2.06%, while the S&P 500 dividend yield is 2.15% (historically, stocks tend to remain strong once their dividend yield surpasses the 10-year yield); the Fed’s inflation target is 2%, and GDP growth has been in the same general 2% range. Not sure what to make of this.
The San Francisco Fed Reserve has apparently explored the concept of a natural rate of interest, and their best estimate is approximately -2.1% (yes, negative), which means the Fed’s current ZIRP strategy still may be too high for current economic conditions. Fed funds futures (which tend to be quite prescient) are forecasting only a 37% chance of a quarter-point rate hike in December and a 43% chance in January.
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