Stock Market Update
The volatility continued last week as stocks enjoyed an oil-inspired short squeeze and recouped all of the previous week’s losses. The S&P 500 finished the week up 3% and now is essentially flat (-0.17%) on the year.
Last week started with a thud, as stocks initially traded lower on Greece and oil before putting in a sharp reversal Monday to close higher by over 1% as oil prices rebounded.
Tuesday, the gains were extended, this time on encouraging M&A chatter between ODP and SPLS, but continued strength in energy also was a big contributor to the rally.
Stocks moderated Wednesday on ECB/Greece concerns but the weakness was short lived, as the S&P followed Europe’s lead higher on Thursday and extended morning gains into the afternoon on further oil strength.
Initially the rally continued Friday, but the jobs number was a bit “too hot” and a surge higher in interest rates and some profit taking resulted in stocks experiencing a modest sell-off Friday afternoon.
Trading Color
We continue to operate on the general premise that the S&P 500 remains stuck between 2,000-2,050 (give or take 20 points on each side). And, while last week’s rally was broad and impressive from a percentage standpoint, internally it wasn’t all that strong and reeked of short covering, further confirming our trading range premise.
The Dow was the best-performing major index, up 3.85% thanks in part to the DIS earnings blowout, but also because the Industrials had gotten very beat up during earnings season due mainly to FX headwinds (so it was a lot of short covering). The Nasdaq lagged somewhat substantially, up just 2.35% while the Russell 2000 slightly outperformed the S&P 500.
Sector wise, the most interesting trend that emerged (and that we think can continue to have legs) is the “higher interest rate” rotation. Despite the focus on energy, banks were actually the best-performing sector last week, as KRE (regional bank ETF) surged more than 8%. Interestingly, that rally happened all week—it wasn’t just Friday in reaction to the jobs report.
Conversely, high yielding/larger dividend sectors got absolutely hammered on Friday. XLU (utility ETF) dropped 4% on Friday, its biggest one-day move in a very long time.
Turning to energy, XLE did have a good week, rallying 5% along with oil, and importantly made a new multi-week high, improving the chart.
XLE now is up against a key downtrend, and if this is just a big short-covering rally, we should see XLE struggle to get above the $80 level. Two or three closes above that resistance would be bullish.
Bottom line from a sector and internals standpoint, the biggest takeaway was the massive bank outperformance, and that’s something that can continue as a “higher rate” sector trade is very, very under-owned right now. More broadly, the internals largely confirm that last week’s rally was mostly short covering, and shorter-term positioning by traders, and does not imply the broad market is about to breakout.
Greece Update
The rhetoric got more combative over the weekend and sentiment is very negative regarding this situation—but beyond the posturing the bond market is telling us a deal to keep Greece in the EU still gets done, eventually. Over the weekend PM Tsipras said he wouldn’t seek an extension of the current bailout, which looks ominous. But, that’s nothing new, as this entire drama is about negotiating a new bailout. The important thing to focus on here is that Greece gets a bridge agreement from the EU for a few months so all sides can negotiate a new bailout. Wednesday is shaping up to be a very big day in this drama (it’s a EU Finance Minster meeting and some progress on that bridge agreement will need to be made by its conclusion).
Bottom Line
It was an impressive move from the Monday lows (1,980) to the Friday highs (2,072) – making it nearly a 100-point, four-day rally. And, as much as I don’t want to be dismissive of the rally, it came without any material positive resolution of the fundamental headwinds, and as such I continue to maintain we’re broadly in this 2,000-2,050 range in the S&P 500. In fact, you could make the case that last week saw another potential macro headwind introduced to the market, as a Fed rate hike in June (and the troughing of inflation in the US) is now in play.
The major catalyst for the rally was a rebound in oil and the stalling of the US Dollar rally, which ignited a major short-covering rally. But despite the moves, several general headwinds on markets remain: Global growth is still suspect, it’s not clear oil has materially bottomed, the US market is now more expensive on a P/E basis following earnings season, and a huge gap remains between market expectations for interest rates and Fed expectations for interest rates.
All of these issues likely will be resolved positively, but that may take several more weeks, and until that happens it’s tough for us to see material upside in markets.
Broadly, we are holding allocations (we are not adding to domestic sectors up here) and our two favorite strategies at the moment remain buying Europe, and domestic consumer-related cyclicals on dips in the S&P 500 towards 2,000.
HEDJ remains our “best idea” over the medium term despite Europe underperforming last week for the first time all year. Fundamentals remain favorable, and the Greece situation, while certainty a risk, still will likely turn out “ok.” If we get to the end of February and no extension of the current bailout program is reached, then that changes things negatively—and that’s the scenario we’re watching.
Domestically, we continue to be bullish on consumer oriented cyclical sectors on any broad market dip towards 2,000: RTH and KRE remain our two favorite sector ETFs, and we are also now getting bullish on small caps, which we think can outperform large caps this year, reversing the 2014 trend (IWM is the Russell 2000 ETF).
Energy remains tempting, but since I do not think we have seen the bottom in oil, I’m staying away from XLE and other energy companies. If XLE breaks that $80 level the technicals get more positive, but for now I don’t think the risk is worth the reward.
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