|Garzarelli Indicators||Up to 85% from 81%|
Even with higher odds (75.0 percent) of a July Fed rate hike, the S&P 500 continues to rally. As the Fed gets ready to raise rates again, policymakers around the world continue to ease. Historically, the S&P 500 rallied until the last rate hike in a cycle. In past cycles, when the Fed raised rates, it was to engineer recessions in order to reduce inflationary pressures. This time, however, the Fed is simply trying to normalize extremely low rates, not trying to destroy economic growth.
Our proprietary stock market indicator composite consists of four groupings of indicators: economic cycle, monetary, valuation, and sentiment. A level below 30.0 percent for the composite is bearish. This week our composite rose to 85.0 percent from 81.0 percent due to the upgrade of our stock newsletter writers’ index, to a bearish extreme. Also, the continued extreme bearishness among hedge fund managers and institutional investors is bullish for stocks - this means a likely melt-up, at some point. As we stated in previous reports, we are buyers during corrections which we believe will be limited to 4.0 to 7.0 percent.
The number of bullish advisors fell to 35.4 percent from 40.2 percent. Since a level below 39.0 percent is bullish, we upgrade this indicator from neutral-plus to bullish! As a contrarian indicator, low bullishness is considered good for stocks since it signifies advisors have kept their funds out of equities, and is potential fuel for stocks. This increase in bearish sentiment reflects advisors uncertainty about the course of oil prices and Fed moves. The adage “stocks climb a wall of worry” pertains to the current situation.
Our junk bond yield ratio indicator (Chart 1) is ranked bullish. Junk bonds have been declining, and that reduces the likelihood of a U.S. recession. Junk bonds fell this week while the 10-year bond yield rose, causing the ratio to decline. Since this indicator has an inverse relationship with stocks, this decline is favorable for stocks.
A multi-year rise in the dollar put pressure on earnings along with lower oil prices. Both have recently changed direction and that is positive for earnings. We look for S&P 500 operating earnings of 122.00 this year (in line with the consensus) and a fair value S&P 500 of 2233, + 7.0 percent from here.
The Bloomberg financial conditions index (Chart 2) is bullish. Indications for the financial industry are positive and most recently U.S. bank loans are up 8.1 percent (y/y) with strength in real estate, C&I, and consumer loans.
The economic cycle research institute weekly leading index (ECRI, Chart 3) rose this week and has been on an uptrend this year. Our readers know we look to this index for early indication of changes in the economic cycle. It’s currently strong and much improved from the negative growth it registered early this year.
First quarter real GDP was revised up to 0.8 percent growth, better than the 0.5 percent pace reported last month. Due to a seasonality distortion, the U.S. economy over the years tends to be weak in the first quarter and rebound in the second.
Economic stats have improved since April. Durable goods orders rose 3.4 percent in April (m/m), led by aircraft orders and home sales up are up +16.6 percent (m/m), prices are up +6.8 percent (m/m), and the value of new house sales increased +24.6 percent (m/m). Mortgage rates below 4.0 percent for seven months have been positive along with the gains in employment and wages. Pending home sales for April rose 5.1 percent, the highest level in a decade. Sales of existing homes, which are based on signed contracts, are up 6.0 percent (y/y) in April, even with the short supply of available homes on the market. This strength in housing quieted market participants’ concerns of a slowdown in consumer spending, a key for continued GDP growth. Strong housing is good for consumer confidence, net worth, and pushes fence-sitters to act.
U.S. capex spending is in recession territory, therefore the health of the consumer is key to offset this for continued economic growth. Capital spending is weak because the operating rate is at 75.4 percent, and a level above 80.0 percent indicates a likely acceleration for capex.
It looks like inflation is moving ahead toward the 2.0 percent objective and gasoline prices were up +8.0 percent in April (m/m), causing the CPI to have the biggest increase in over three years (+0.4 percent). Gasoline prices continue to rise this month by another +8.0 percent and higher gasoline prices end up in higher core prices.
Table 1 lists all the sectors in the S&P 500 with their associated ETFs. For those interested, we also list the ETFs that seek a return that is 1x, 2x, and 3x the return of the index for a single day. They should be used for short-term trades only. The S&P weights are indicated for all the sectors as well as our recommend weights.
We underweight those sectors that we do not expect to have superior returns to the S&P 500. We believe the weighting for each issue should be based on one’s individual situation and preference.
As indicated in Table 1, due to a recovery in oil prices and increased global stimulus, we like the ETFs for Tech (XLK), financials (XLF), consumer discretionary (XLY), industrials (XLI), energy (XLE), and materials (XLB) - all are overweight the S&P 500. Health care (XLV), consumer staples (XLP), utilities (XLU) and telecoms (IYZ) are underweighted the S&P 500. (*Leveraged ETF to be used for less than 3 months.)
ETF Tables are for subscribers only. If you'd like to view the ETF Table, click here to subscribe.