New Year Commences With A Bullish Optimism, But Will It Last?

Investors continue to be sanguine about the economy and are reluctant to lighten up on stocks, even as we enter the New Year on the heels of a big post-election run-up, perhaps for fear of missing out on continued upside. Rather than fearing the uncertainty of a new (and maverick) administration, they instead have an expectation of a more business-friendly environment, fiscal stimulus, and a desirably higher level of inflation under Trump and a Republican-controlled congress. Stimulus likely would include lower corporate and personal taxes, immediate expensing of capital investment (rather than depreciating over time), incentives to repatriate offshore-held cash, reduced regulatory burdens, and infrastructure spending programs. Longer term, we also might see more favorable international trade deals and a freer market for healthcare coverage. Even the Fed is finally admitting that monetary stimulus alone can’t do the trick.

As the New Year gets underway, the technical picture remains strong, as the Dow is gathering strength to challenge ominous psychological round-number resistance at 20,000 and market breadth is impressive, led by small caps and value stocks. I believe we have a favorable environment for US equities going forward – especially fundamentals-based portfolios, like Sabrient’s annual Baker’s Dozen.

In this periodic update, I give my view of the current market environment, offer a technical analysis of the S&P 500 chart, review Sabrient’s weekly fundamentals-based SectorCast rankings of the ten U.S. business sectors, and then offer up some actionable ETF trading ideas. Overall, our sector rankings still look bullish, and the sector rotation model continues to suggest a bullish stance.

Market overview:

Investors now seem willing to ignore the news headlines that were so distracting for so long and instead focus on the many positive fundamentals. Starting in summer 2015 until mid-February 2016, fundamentals simply didn’t matter as election campaign rhetoric and news about China growth and currency, Fed monetary policy, and oil prices were all the mattered each day. Market leadership was narrow and dominated by a handful of mega cap favorites (e.g., “FANG”). Then, in mid-February 2016, the markets reversed to the upside, led at first by the normal oversold short-covering before broadening to include fundamentally solid companies with attractive valuations. This broadening continued throughout the year, with brief speed bumps caused by things like the Brexit vote, heinous terrorist attacks, and the lead-up to the presidential election, among others. The combination of the election result and higher oil prices led to outperformance by year end in Energy and Financial stocks. Now, as the New Year commences, we continue to witness healthy market breadth and diverse leadership from economically sensitive sectors, and particularly from value and small cap stocks.

Impressively, the global market for exchange-traded products (ETPs, which includes ETFs and ETNs) had another banner year, achieving another new record high. First Trust Advisors was the big winner in net inflows with over $3 billion, according to ETFGI. The top performing non-leveraged ETFs of 2016 include PureFunds Junior Silver Miners (SILJ) at +150%, and VanEck Vectors Russia Small-Cap ETF (RSXJ) at +105%.

I was telling advisors since the beginning of 2016 that I expected a double-digit gain for the S&P 500 by the end of the year. As you recall, the S&P 500 index began the year with its worst January performance in history (-10.5%) after China devalued its currency and slapped controls on its stock market, leading to fears of a hard landing. So things weren’t looking so good (re: “January effect”) when I was talking about double-digit gains. But I knew that fundamentals were solid, there was no recession in sight, and the only thing apparently holding back stock prices was fear of the unknown. The S&P 500 ended up the year with a gain of +9.5% (price index), even after giving back nearly 2% in the last two weeks of the year. Including dividends, its total return was nearly +12%. The Dow Industrial Average finished up +13.4%, with Goldman Sachs (GS) contributing the most to this price-weighted index, while Nike (NKE) hurt it the most. Nasdaq was up a respectable +7.5%. But most encouragingly, small caps were particularly strong with the Russell 2000 up +19.7% and the S&P 600 up +24.7%. Notably, all the small cap outperformance came after the presidential election.

Although MSCI emerging markets price index was up for the year by +8.1% (+10.9% total return), it is notable that ever since the election it has diverged from US equities, likely due to the expected negative impact of rising interest rates and a strengthening dollar on emerging market countries that carry dollar-denominated debt. Moreover, during the past decade, the average annual total return of the S&P 500 index was +6.87%/yr while the MSCI Emerging Markets index was +1.09%/yr. Thus, some say that global markets are destined to outperform after such a lengthy period of underperformance – due to mean reversion, if nothing else.

Brazil had a strong recovery year, with its stock market the biggest gainer on the global stage rising +69% as measured in US dollars. Worst performing was China at -18% in USD. Natural gas and crude oil were particularly strong, with oil closing the year at $55 – a “Goldilocks” level that is high enough for the industry to earn profit and justify capital investments but still low enough for consumers to tolerate prices at the pump. Gold finished at +8% and silver +16%. The US dollar rose +20% vs. Mexico peso, +3.3% vs. euro, and +6.9% vs. China yuan, but fell -15.2% vs. Russia ruble and -17.8% vs. Brazil real.

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Disclosure: Scott Martindale is ...

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