U.S. Equity Market Radar (April 14, 2014)

U.S. Equity Market Radar (April 14, 2014)

The S&P 500 Index had its worst weekly decline since 2012, falling 2.65 percent. Utilities were the only sector to eke out a gain as bonds rallied and money flowed into defensive areas of the market.

S&P Economic Sectors
click to enlarge

While the major indices have experienced some volatility, under the surface the market is really churning. If youā€™ve followed the financial news in recent weeks, biotechnology and Internet-related names have been hit extremely hard, while other areas of the market that exhibit classic value characteristics have outperformed. This bifurcation has been extremely sharp and is difficult for analysts and market commentators to explain, even in hindsight. What has occurred is a massive shift from high growth stocks, with some trading at arguably-stretched valuations, into value stocks ā€“ a global phenomenon.

The chart below plots the PowerShares QQQ Trust ETF (which seeks to replicate the NASDAQ 100) and the iShares MSCI Emerging Markets ETF (EEM). At the same time that we witnessed the shift out of growth and into value in the U.S., money also flowed into the beaten up emerging market space. As can be seen in the chart, since the end of February the EEM has risen by about 6 percent, while the QQQ has fallen by about 6 percent, with a sharp inflection point in mid-March. One interesting angle to this recent price action is that the apparent risk aversion has not spread to other areas of the market that would normally be impacted, such as high-yield bonds or a spike in the VIX Index.

Sudden Divergence in the Marketplace
click to enlarge

At U.S. Global Investors, we seek to invest in high-quality companies with robust fundamentals that trade at reasonable valuations. Companies that are growing rapidly tend to trade at higher valuation multiples, but when adjusted for growth, still appear reasonably valued. In the most recent sell-off, the selling appeared somewhat indiscriminant, as companies trading at multiples below their growth rates sold off as hard as or harder than companies trading well in excess of their growth rates. Over the long run, robust fundamentals and reasonable valuations should prevail, and we believe our models will continue to point us in the right direction.

Take a look at Director of Research John Derrick as he explains what we learn from watching the ups and downs of sectors over time.

Strengths

  • The utilities sector rose 0.53 percent this week as a general flight-to-safety trade took place and bond yields rallied.
  • A small diverse collection of industry groups were able to generate positive returns this week including agricultural products, health care real estate investment trusts (REITs) and wireless services.
  • Allergan was the best performer in the S&P 500, rising 3.65 percent this week. Johnson & Johnson announced its decision to exit its Botox business this week, which should be incrementally positive for Allergan, as a competitor leaves the market.

Weaknesses

  • The health care sector was the worst performer this week falling by more than 4 percent, as 53 of the 54 index constituents were down for the week. Biotechnology names continued to underperform, but the weakness extended well beyond these names.
  • The financials sector was also down about 4 percent with many regional banks giving up recent gains as bond yields fell and expectations for higher, short-term rates faded, which would have been positive for the banks. JP Morgan also reported first-quarter earnings on Friday, which disappointed the market. The stock fell 7.54 percent for the week.
  • Intuitive Surgical was the worst performer in the S&P 500 this week, falling 13.03 percent. The company announced that sales of its robotic surgery systems fell sharply in the first quarter, coming up short of expectations.

Opportunities

  • The current macro environment remains positive as economic data remains robust enough to give investors confidence in an economic recovery, but not too strong as to force the Federal Reserve to aggressively change course in the near term.
  • The sell-off in high quality companies offers an opportunity to pick up companies with robust fundamentals at attractive prices.
  • The improving economic situation could possibly drive equity prices well into 2014.

Threats

  • A short-term market consolidation period after such strong performance over the past six months cannot be ruled out.
  • Higher interest rates are a threat for the whole economy. The Fed must walk a fine line and the potential for policy error is large.
  • Quarterly earnings reports come out in earnest next week, and with JP Morgan disappointing on Friday, it sets a negative precedent to start the week.
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