By David Nelson, CFA
After taking a standing eight count the aging U.S. Bull Market makes a Rocky Balboa comeback. October’s performance to date is one of the best in years.
There were a few hints along the way. The successful retest in late September and the positive signal from the Bullish Percent index were early flags but nothing definitive especially in the face of weakening economic data and lowered expectations.
The correction never turned into a full blown bear market. Earlier this year I mentioned the slope of long term moving averages like the 200 day which for the first time in months is finally flat. It’s important in coming weeks to see the slope turn positive. We start the week in overbought territory however, I believe pullbacks will find buyers especially near the 2000 level of the SPX.
The tide isn’t lifting all boats
Last week’s price action tells a story. The differentiation between winners and losers is notable. I lost count of the number of stocks that were up or down more than 20% on the week. While Friday’s action was led by Google (GOOGL) and Amazon’s (AMZN) strong earnings reports, I couldn’t help but notice other important companies like Target (TGT) were down over (-5%). It’s becoming clear many industries are hitting an inflection point, in particular retail. The Amazon effect is punishing traditional business models. This was clearly behind the painful admission by Walmart (WMT) executives when they lowered expectations forced to pay higher wages and invest heavily to boost their online presence.
In the industrial sector firms like Caterpillar (CAT) continue to see headwinds especially in growth areas like China while aerospace and defense giant Boeing (BA) knocked the ball out of the park registering a big beat.
Tech has their share of haves and have nots as well. IBM continues to disappoint attempting to hide behind the cloud while Amazon (AMZN) AWS services are the cloud, growing at 78% in its most recently reported quarter.
Sectors
Energy stocks are the hands down winner in October up over 11% with Utilities bringing up the rear down (-4.7%) All the more notable because crude is actually down on the month.
Sector rotation has played a role all year. The rotation graph below is for the last 12 weeks. Every sector at some point this year has been in the lagging quadrant.
Healthcare – Darling to Pariah
The VIX sitting below its 200 moving average doesn’t speak to the carnage taking place within the Healthcare Sector. Healthcare has been under pressure for weeks as rhetoric in and outside Washington takes aim at pricing models in the industry. Adding fuel to the fire are allegations questioning the accounting at Hedge Fund darling Valeant (VRX) down 55% from its August high. (Monday morning management is hosting a conference call to explain their relationship with specialty pharmacies)
Buybacks
According to Goldman Sachs Buyback announcements are up 50% from last year to $521 Billion. While buybacks can do wonders for short term returns they do almost nothing for the long-term health of companies or the economy. Buybacks come at the expense of R&D and Capex. It’s understandable why management takes this route as it props up near term earnings making it easier to hit generous stock compensation packages.
The next leg of the bull market isn’t going to be led by this metric. Spend more time and money developing new products and services. That’s the key to long term success. Financial engineering just postpones the inevitable. One look at the poster child of buybacks IBM says it all.
Busy Week
We’re well into the earnings season but the coming week is about as busy as it gets. On top of a full plate of reports including Apple (AAPL), Exxon (XOM) and Merck (MRK) we get the FOMC rate decision. I’m not even going to speculate given all the noise we’ve heard from Fed officials. Regardless of the outcome the day’s following will include a parade of governors doing their best to confuse investors with conflicting statements.
I’ve been on record for some time that the Fed is behind the curve and should raise rates. I’ll say it once again. We’ve come a long way since the depths of the financial crisis. Current rates influence corporate behavior in a negative fashion even encouraging management to focus on buy backs rather than needed investments in R&D or Capex. Zero is the wrong number.
