As everyone knows, stocks do not go up in a straight line, not even during the holidays. So although the future looks bright for U.S. equities as the major indexes continue to hit or challenge new highs, the market has been gasping for a breather to gather bullish conviction. My fear has been that we might not see it until January, which likely would have resulted in a more severe correction at that time. But falling oil prices and a weak Energy sector seems to have introduced a reason to sell this week. Correspondingly, the Energy sector is now ranked at the bottom of our fundamentals-based, forward-looking sector rankings.
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:
In the fall of 1999, my older daughter was in kindergarten, and I met another father at her school who had moved his family to Santa Barbara from Puerto Rico. He had enjoyed success with real estate and construction there and owned free-and-clear a large house in downtown San Juan. As his kids were ready to start attending school, he decided to monetize his big house by leasing it out. But rather than using the lease payments as income to live on, he took out a large mortgage on his house and gave it to his financial advisor back home to invest for him. After all, stocks were raging and his broker was enamored with the performance of the NASDAQ Composite Index. All his money was invested in NASDAQ stocks, particularly the Technology sector.
The following spring of 2000, as the index approached its incredible closing high of 5,048 (or 5,132 intraday), he was getting more and more anxious about the meteoric rise. And as the market began its fateful decline, his broker kept telling him not to worry because new technologies were the engine for all future of global economic growth. But fears of Y2K doom-and-gloom proved unfounded, and instead budgets were slashed for further capital upgrades. Software company valuations based solely on projected revenues rather than earnings were chopped off at the knees. Dot-com valuations that were based solely on web site visits (a.k.a., eyeballs) became dot-bombs. Ultimately, my friend’s investment account was decimated and his brief retirement (in his 30’s) had to end. He returned to the construction business back in Puerto Rico.
Today, the NASDAQ is once again approaching the 5,000 level for the first time in nearly 15 years. Over the past two years as U.S. economic recovery has taken shape, the index is up almost 2,000 points (70%). So the logical question is whether there is more validity to this valuation level (beyond the impact of inflation, of course).
Well, some things are quite different this time. With a trailing P/E around 20, NASDAQ stocks display an average P/E that is actually about the same as the S&P MidCap 400 Index. But many market observers still believe that Fed’s easy money policy has inflated the valuations for many speculative stocks.
Not to be outdone, the Dow Industrials blue chip average is knocking on the door at 18,000. The S&P 500 large caps are eyeing 2,100. The combination of economic weakness outside the U.S. and increasing U.S. oil production continues to push down the price of oil, which on the surface should create a wealth effect among consumers. Hiring is on pace to make 2014 the strongest for job growth since 1999. And of course, we are in a seasonally strong time of year, which has been bolstered by recent short covering among hedge funds and share buyback activity among corporations. And despite worries about a slowdown in China’s growth, the Shanghai index is up about 40% this year.
