SET Monthly Issue October 2015

| October 20, 2015

Earnings Versus The Fed – 

What Will Drive The Markets Next Move?

Right now new information is coming at us on a daily basis.  And it’s a challenge to make heads or tails of it.

The environment is so difficult that many hedge funds are throwing in the towel.  More than 400 hedge funds simply shut down and returned money to investors in the first half of the year.

Here’s what we know…

The global economy is struggling.  Consumers aren’t increasing spending.  Inflation is non-existent.  And the jobs market is weakening.

We’ve known for some time that economic growth is slowing in China and other emerging markets.  What’s more, just about every major developed economy outside of the US has been dealing with issues as well.

It was only a matter of time until the weakness in the global economy had an impact on the US economy.

Now we’re seeing this impact on US economic data. Industrial production slumped in September and a gauge of future industrial production shows this slump is likely to continue.

And the consumer spending data isn’t any better.  Retail sales grew a paltry 0.1% in September after being unchanged in August.

That’s six out of the nine months so far in 2015 that retail sales slowed or were flat from the previous month!

This weakness is hitting the top and bottom line across a wide swath of corporate America.  We’ve already seen companies like Wal-Mart $WMT and several luxury retailers miss expectations by a wide mark in the 3rd quarter.

The bad news is so widespread that it was actually good news for stocks.

How can that be?

Simple, there’s no chance that the Fed is going to raise interest rates when there economy is slowing and inflation is running below their target.

So, the poor economic data has pushed out the timing of the first Fed rate hike until sometime in 2016.  The continuation of the Fed’s zero interest rate policy, or ZIRP, is being viewed as beneficial to stocks.

What’s more, it’s having a negative impact on the US Dollar.

US Dollar

As you can see, the US Dollar is nearly 6% below the March 2015 peak.  This should help stabilize commodity prices as well as revenues US companies generate outside the US.

In fact, the reversal of the US Dollar is the key take away.  Here’s how you can profit from it…

Trade Alert: Energy Stocks Poised For a Comeback

The oil market has been plagued by several key headwinds impacting supply and demand.

On the demand side, sluggish global economic growth has hurt demand.  Companies and individuals are simply consuming less oil than they would if the economy was growing faster.

But the biggest impact has come from the supply side.

OPEC and US oil production have soared over the last few years.  The increase in production has been led by US shale oil production.  It has gone from next to nothing in 2010 to around 4 million bpd in 2015.

At the same time, OPEC has exceeded its official production target for 16 months in a row as they defended their share of the oil market.

The result…  The last 16 months have been brutal for oil prices.  The price of a barrel of West Texas Intermediate Crude Oil fell 65% from the June 2014 peak to the August 2015 trough.

Macro/Economic Trend:  Oil Industry Rebalancing

Here’s what the EIA says about oil production and consumption.

Global consumption of oil has grown 3.5% since the first quarter of 2014 to 94.55 million barrels per day.  At the same time, production has grown 4.8% to 96.34 mbpd.

In short, that’s a supply glut.

Now, the impact of lower oil prices is starting to have an impact on US oil production.

According to the former head of oil firm EOG Resources, Mark Papa, “We are about to see a pretty dramatic decline in U.S. production growth.”

US oil production has peaked.  It’s expected to fall from 9.6 mbpd to 8.6 mbpd in 2016.  This is the turning point for crude oil.  The market is coming back into balance and oil prices are set to go higher in the months ahead.

What’s more, the weakness in the US Dollar will also help oil prices.

As you can see, the US Dollar price and the price of WTIC crude oil prices are inversely correlated.  The biggest drop in crude oil prices happened when the US Dollar was rocketing higher in value relative to other global currencies.


Now the US Dollar is retreating lower.  This should help support oil prices as the supply and demand fundamentals come back into balance.

I’m recommending the Vanguard Energy ETF $VDE.

Fundamentals:  A closer look at VDE

VDE tracks the MSCI US Investable Market Energy 25/50 Index.  It includes large, medium, and small cap energy companies.  It currently holds 151 stocks according to their market capitalization.  It has an expense ratio is 0.12%.

The top five holdings and percentage weight for VDE are –

Company Name Ticker % Weight
Exxon Mobil XOM 21.87%
Chevron CVX 10.59%
Schlumberger SLB 6.83%
ConocoPhillips COP 4.21%
Kinder Morgan KMI 4.15%

Technicals:  The charts lead the way 

VDE is currently trading for $94.21.  It’s down 13.7% year-to-date and 24.8% from the 52-week high.  But it’s up 8.0% over the last month and up 16.8% from the 52-week low.

Vanguard Energy ETF

There is a bullish moving average crossover on the chart.  The 20-day moving average recently crossed above the 50-day moving average for the first time in five months.

This crossover points to a revival of bullish momentum for VDE.

Trade Alert

BuyVanguard Energy ETF $VDE up to $97.50

Recent Price: $94.21

Price Target: $110.00

Stop Loss:  $82.50

Remember:  We’ve been waiting for signs of a bottom in crude oil prices.  Now we have them.  The industry is rebalancing, the supply glut will soon be gone, and a weakening US Dollar will help support oil price increases.

Sector Snapshots

Consumer Discretionary (+4.9%)

Consumer discretionary stocks rebounded over the last month.  The sector is now within 2.5% of the 52-week high.  The gains were supported by high levels of consumer confidence and low oil prices.

But we’re seeing weak 3rd quarter earnings from luxury retailers as well as Wal-Mart, as the company increases employee pay and competes on low prices.

I doubt we’ll see new 52-week highs anytime soon.  That could lead to more selling and a rough few months for consumer stocks.

Consumer Staples (+6.5%)

Consumer staples surged 6.5% over the last month.  And it’s quickly closing in on resistance from the previous highs.  The dovish Fed is clearly helping this sector rebound… but it likely won’t be enough to trigger a breakout to new highs.

Energy (+6.1%)

The energy sector has been beaten down by a 65% drop in oil prices.  But the fundamentals are changing in favor of higher oil prices.  We’re recommending the Vanguard Energy ETF $VDE this month… see page 5 for more details.

Financials (+2.2%)

Financials have rebounded off the recent lows.  The industry was helped by an uptick in bank earnings.  But the majority of these gains are due to lower legal bills after settling lawsuits over bad mortgages made prior to the 2008 financial crisis.  Revenue growth is still a pipe dream for many large financial institutions in the new regulatory environment.

Healthcare (-0.3%)

Healthcare stocks have been unseated as the top performing sector this year.  The sector has been hit by a wave of negative news about excessive price increases in the drug industry.

Biotech stocks are recovering after a major correction.  The good news is our ALPS Medical Breakthroughs ETF $SBIO is already moving higher again.  This volatile ETF should continue moving higher from here.

Our iShares US Medical Devices ETF $IHI is battling through some short term resistance at the 50-day moving average.  There’s still upside for this industry… continue holding.

Industrials (+2.7%)

Industrials stocks have rebounded as the US Dollar has weakened and the timeline for the first Fed rate hike has been pushed out into 2016.

Our US Global Jets ETF $JETS is pushing up against resistance of the previous highs.  I’m expecting solid 3rd quarter earnings to trigger a breakout in short order.  Continue holding.

Technology (+4.6%)

Technology stocks are moving higher as a wave of M&A activity sweeps through the sector.  And more M&A deals in the semiconductor industry are likely before the end of the year.  This should help lift the sector higher as the impact of less competition and lower expenses finds its way to the bottom line.

Materials (+2.1%)

Materials stocks are getting a lift from the weaker US Dollar.  But oversupply problems and weak economic growth remain serious headwinds for the sector.  Don’t forget, the sector is still down 8.7% this year even after a 2.1% gain over the last month.

Utilities (+8.7%) 

Utilities had a great month as the timelines for the first Fed rate hike was pushed out into 2016.  Our recommendation from last month, Utilities Select Sector SPDR $XLU, is up 9.4% including the 40 cent per share dividend.  Continue holding.

Portfolio Changes

  • This month we’re buying VDE.

Category: SET Monthly Issues

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