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Is it really so odd that the U.S. stock markets are running up so much this year on so little volume?
The summer months are notorious for low-volume trading, so we shouldn’t be surprised by the continued upward drift of the S&P 500 that began before the first-quarter earnings season came around. During that most recent reporting period, companies generally performed slightly better than expected in terms of earnings growth, while still lagging in revenue growth.
And while the market is bidding up some of the “left behind” sectors in this most recent post-earnings melt-up, the impetus in either direction in the short-term is far more macro (speculation about global central bank action and global economic prospects). And the message we received from first-quarter earnings has been lost on the minds of even the institutional side of the investing population.
When I see the Weiss Ratings set deteriorating in aggregate (more downgrades than upgrades), like I have since earlier this spring, and the market indices rising more than the fundamental signals warrant, I adhere more closely to my service’s discipline of favoring highly-rated stocks over lower-rated ones.
However, when I see a bottoming of an individual sector that had been on the downswing — like I have witnessed in the healthcare sector — I begin searching for where investor fervor may have waned in recent days.
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| Keep the healthcare sector on your radar as we move into July and toward second-quarter earnings season. |
Year to date, the most defensive sector of all, utilities, is up about 12 percent. Â At the beginning of 2014, I would have thought that outcome unlikely. It appeared to me then, as it does now, that the U.S. economy — as well as the global economy — is still in the midst of a “muddle-through” recovery from the depths of 2008-09. In my subscription service, I am adding to my pro-cyclical exposures, guided by the continued strength and Weiss Ratings-resiliency of stocks in the financial, energy and IT sectors.
That said, it’s hard to ignore the fact that even if there is no fundamental/financial support for some stocks, merger & acquisition activity highlights the notion of promising value in a fundamentally challenged sector. I cite the recent announcement that Medtronic (MDT — Rated A) plans to acquire Covidien (COV — Rated B+) as an example of the type of activity that we, as investors, really need to follow closely this summer.
Healthcare is a political issue in the U.S., where we’ll have elections after this summer of uncertainty passes. Some parts of Obamacare may be in danger of modification. So maybe it’s not so surprising to see this large-ticket (~$43 billion) MDT bid for COV. The strategic basis for making the bid has to do not only with cost savings for MDT (the rationale behind a “financial acquisition” tactic), but also to better position the firm to deal with hospital and other care-giving firms (the “strategic acquisition” rationale).
I also recognize that the macro indicators that matter — including the continued retreat by the U.S. Federal Reserve from the open-market purchase of bonds — helped support higher stock valuations. But I don’t see any reason to shun stocks right now. And from the most recent industrial/manufacturing data, it seems clear that the muddle-through continues, economically.
Healthcare is a sector where the Weiss Ratings deteriorated several months ago, but where some leading firms still sport enticing fundamentals. I’d focus on the health insurance sub-industry. We see large-caps like Aetna (AET — Rated A), UnitedHealth Group (UNH — Rated A) and Humana (HUM — Rated A-) in this space looking like strong long-haul investments.
We’re likely to see some changes in bargaining leverage in the HC sphere (drug makers vs. insurers; hospitals vs. drug, supply and device manufacturers; etc.) as the changes in the U.S. market take hold. That said, when I see a sector’s Weiss Ratings drop as precipitously as those I have seen for healthcare so far this year while at the same time stock price rises make the sector the third-best performer, it typically spells trouble from an investing stance.
Bottom line, though, there are clearly some lower-rated stocks in this sector that I am now very interested in pursuing. The Weiss Ratings for the sector seem to have bottomed here (my main criterion), the expectations for firms in the sector are quite low going forward and there seems to be solid investor support for the sector.
I’m still focusing on the pro-cyclical sectors cited above for the Weiss Ratings Portfolio, but situations like a potential ratings bottoming speaks more strongly to me than most other fundamental signals. Keep this sector on your radar as we move into July and toward second-quarter earnings season. There may well be a rotation into healthcare.
Best,
Don Lucek
