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Tech And Healthcare Lead A Surging Market To New Heights

July lived up to its history as a typically solid month for stocks, and 2H2017 is off to a strong start. Technology and Healthcare sectors continue to be the year-to-date leaders, and lately Utilities has gotten into the act on an income play as interest rates stay low. Large cap, mid cap, and small cap indices all continue to set all-time closing highs, while the CBOE Volatility Index (VIX) hit an all-time low last week. The 22,000 level on the Dow was just surpassed on a closing basis on Wednesday, and the 2,500 level on the S&P 500 beckons. Nasdaq has now shown positive performance in 11 of the past 13 months, so a little retrenchment is no surprise – if for no other reason but to take a breather and let other market segments play catch-up.

Although there are of course worrisome issues everywhere you look, the good news is that the global economy is strengthening, the Fed and other central banks are taking pains not to screw things up on their paths to “normalization,” and as a successful Q2 earnings season winds down, a weaker dollar should lead to a better Q3 than is currently forecasted. So, I would say that on balance, things continue to look encouraging. But as valuations in the mega caps (e.g., FAAMG) continue to rise, it finally may be time for small caps to seize the baton and start to outperform.

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. In summary, our sector rankings still look bullish, while the sector rotation model maintains its bullish bias, and the climate overall still seems favorable for risk assets like equities. However, while I was optimistic about solid market performance going into July, I think August might be a different story if the new levels of psychological resistance fail to break and volatility rears its head in this typically-languid month. Read on....

Market overview:

Overall, the signs are positive for stocks and only a significant rise in short-term interest rates leading to an inverted yield curve or a marked deterioration in corporate earnings would suggest an imminent end to the bulls’ party. Let’s explore the likelihood of these eventualities.

With about 60% of the S&P 500 companies having announced 2Q2017 results, 71% have beaten analyst consensus top-line estimates and 73% have beaten earnings estimates. Average year-over-year sales growth is 5.0% (with a big boost from the Energy sector), and average YOY earnings growth is 10.8%. We are seeing how a weaker dollar can support organic sales and earnings growth. The Technology and Healthcare sectors have been the leaders, at least partly due to investors seeking market segments that can thrive with or without fiscal stimulus.

Technology is up +21.4% YTD through Wednesday, followed by Healthcare at +15.6%, while Energy is the worst at -12.9%. Apple (AAPL) certainly continues to set the world on fire, posting stellar revenue growth and getting a nice pop (and it is +35.7% YTD). Tech is the only sector that is expected to see double-digit growth, and yet overall it still isn’t too overvalued in comparison with the broad market, with the exception of a few names. Just when you think it can’t continue its torrid growth rate, it surprises. Still, like many of the mega-caps, one would think that the law of large numbers will eventually slow the rate of growth (as one would expect for China’s growth rate).

One such name is (AMZN), which sports a trailing P/E of 187 and a forward P/E of 88 while ploughing its own unique path of destruction in search of world dominance, with Jeff Bezos playing the role of Dr. Evil (from the Austin Powers movie). Although it has been struggling to regain the $1,000 price level and its 50-day simple moving average since falling below both after a disappointing earnings report and forward guidance, Amazon has been laying waste to the retail sector with its take-no-prisoners scorched-earth policy of gobbling up market share no matter the cost, and it is up +32.8% YTD.

Remember when big box stores and discounters like Walmart (WMT), Costco (COST), Target (TGT), and Home Depot (HD) first came on the scene and the public lamented how they were savagely wiping out the mom-and-pop retailers? Amazon puts them all to shame in this regard. I saw some statistics on announced retail store closures this year alone from Business Insider. They counted 6,375 closure announcements in 2017, including 1,430 Radio Shacks and 808 at Payless, plus the likes of Gymboree, The Limited, Kmart, Gamestop, JCPenney, Sears, Staples, and Macy’s, among others. Next, Amazon has targeted the grocery business with its acquisition of Whole Foods Market (WFM), and some are suggesting that the juggernaut may soon test the competitive moat that Ulta Beauty (ULTA) has established.

Then there is the distressing drop in sales among automakers, when comparing monthly sales this year to last year’s. For example, Ford Motor (F) saw a -7.5% drop in July sales versus July 2016, including -7% in trucks and -19% in cars. This is one upset that can’t be blamed on the Amazon effect, in which sales are simply shifting from one retailer to Amazon. On the other hand, many chalk up the fall to the “hangover” after the buying spree from the pent-up demand and the extreme sales incentives being offered. But what can’t be ignored is the likely impact on middle America of the growing wealth gap and lack of wage inflation brought about by our singular reliance on monetary stimulus (and its associated asset inflation) to prop up the economy without complementary fiscal stimulus.

Sabrient’s wholly-owned subsidiary Gradient Analytics, a forensic accounting and earnings quality research firm, has written a number of negative reports this year on firms from the retail and apparel industry. These reports are sent to a clientele of mostly long/short hedge funds that might put short positions on these names. But it’s not that Gradient has made a top-down macro call on the retail industry like an activist short-seller might. Rather, the firm’s bottom-up process – identifying things like outsized growth in receivables and inventories relative to sales, along with fundamental drivers that suggest these issues might worsen in the near term – continues to flag names in this space.

Other worries include the sudden weakness in the Dow Transportation Average. After hitting an all-time high on July 14, it has since fallen nearly -7% in precipitous fashion, cutting straight through its 50-day and 100-day simple moving averages like they offered no support at all, and now seeking support from the critical 200-day. Its -3.5% overall July performance was its worst month since the Brexit vote in June 2016. Also, the US dollar continues to fall and is now at levels not seen since 2014. This is the dollar’s longest losing streak since 2011 when S&P downgraded US debt on the budget impasse. In addition, credit card companies (including many banks) may be feeling nervous as their net charge-off rate has been rising for several quarters, reaching its highest level in four years. Despite the increase, it still sits at only 3.3% -- well below the peak of 10% (in 2010).

Of course, political dysfunction and backstabbing continues, with disgraceful pandering by the media to the fringe elements of the political spectrum in search of ratings, and with too much focus on conspiracy theories and special prosecutors – to the detriment of the enactment of pro-growth fiscal policies that might actually help the average American who is struggling with stagnant wages, too much debt and tax burden, and too little in the way of appreciating assets.

And then we have the many other intractable problems here at home and around the world, like ICBM launches from North Korea, heated rhetoric/sanctions with both Russia and China, suffocating municipal and corporate pension liabilities, health care in turmoil, a looming crisis with the federal budget and debt ceiling, crumbling US infrastructure, the daily threat of global terrorism, Venezuela moving toward civil war, and the growing credit bubble in China. Talk about a market climbing a “Wall of Worry.”

Speaking of China, its National Bureau of Statistics announced that GDP expanded at a 6.9% annual rate in Q2. This acceleration in growth was boosted by a surge in both exports and imports, so for now, all appears to be well. Nonetheless, I continue to see China as the primary risk factor to the global economy, given the ever-growing credit bubble and the threat of a large...