On Tuesday the broad market indexes rose 0.7% as buyers were once again willing to step in and buy stocks. Energy, Financials, Healthcare and Consumer Discretionary each rose more than one percent on the day. None of those moves produced a new high, but they did confirm the continued leadership for those sectors overall. Telecom, Technology, Industrials and Consumer Staples couldn’t provide the help to make it a bigger push to the upside. Utilities and Telecom were a drag on the downside as both struggle with rising interest rates on bonds. Putting it all together and the call for the sellers/bears to take control of the markets, faded away.
Thus, the pressure is on the bears! If they believe the market is overvalued, now is the time to stand up and be counted. There was some selling throughout the day following a positive open to the upside, but in the end the sellers were a no show relative to taking back control on the day. No follow through to last weeks worries about the Fed cutting stimulus, no follow through on the worry about earnings power being lowered, no follow through on the worry about the economy… simply no follow through on selling. Thus, the bulls/buyers are still in control of the market direction and they validated that again on Tuesday.
Where do we go from here? That is anyones guess in all sincerity. The consensus is higher, buyers want to step in and put more cash to work. The nervous nellies want to run and hide money is cash equivalents. For now the market is winning and investors are voting with their money by putting it to work in stocks. There are many who believe the biggest gains are yet to come. The bottom line… only time will tell.
From my view the greatest challenge is finding valuations that are reasonable enough to warrant the risk of putting money to work. Since hitting stops last week on positions resulting from the selling on Wednesday, I have been scanning the sectors and evaluating where the best opportunities lie. The interesting part is value stocks are ‘overvalued’ fundamentally (they could remain that way for some time to come.) and don’t warrant the risk for the potential reward. However, growth stocks are undervalued fundamentally (they could remain that way as well for some time to come.) and offer some opportunities, but they have been the first ones dumped at any signs or sounds of trouble. Thus, the key from my view is to be patient and let the opportunities present themselves.
Utilities are in decline mode short term. The downside pressure is mounting as XLU breaks support $39.40 and is testing support at the $38.25 mark. Why all the selling? Simply put, the valuations are a little on the rich side as the sector is trading at 16 times earnings. Throw in rising interest rates and you get additional downside pressure as the dividend yield is 3.7% on XLU and the 30 year bond yield closed at 3.3% on Tuesday. The yield spread is getting too close and the risk/reward is rising. Stops were hit on the sector and downside plays have been attractive as trades, but look for support as rates level off near term.
Bonds continue to drop as a result of rising interest rates. Both the 10 and 30 year bond jumped 12 basis points in yield on Tuesday dropping bond prices more than 2.5% on the day. Elevated risk will put pressure on the bond prices short term. High yield, municipal and corporate bonds have all declined in value over the last two weeks. The weakness from rising rates in the interest sensitive sectors is mounting and attention needs to be given to portfolios housing such assets. You need to hedge or exit the positions as the risk isn’t done yet. Even fixed income assets have to manage the potential risks.
We are watching to see how the markets play out in the short term. More upside? Downside? Sideways? The buyers are still willing to commit money short term. If the bears are going to take control… they need to circle the wagons and make some progress in that direction. I am not holding my breath on that one.