Last week, the S&P 500 put up its best week of the year, closing above key psychological levels and breaking through bearish technical resistance, with bulls largely inspired by the dovish FOMC meeting minutes. But this year’s market has been news-driven and quite difficult for traders to read. Even our fundamentals-based and quality-oriented quant models have struggled to perform. With corporate earnings season now underway, equities might take a breather at this point of the oversold rally until some clarity from key corporate bellwethers begins to take shape, particularly with respect to forward guidance. But despite severe global headwinds, there remain strong reasons for optimism here at home.

In this weekly update, I give my view of the current market environment, offer a technical analysis of the S&P 500 chart, review our weekly fundamentals-based SectorCast rankings of the ten U.S. business sectors, and then offer up some actionable trading ideas, including a sector rotation strategy using ETFs and an enhanced version using top-ranked stocks from the top-ranked sectors.

Market overview:

Last week, the S&P 500 closed up +3.3% for the week, its best performance of the year so far. The S&P 500 large caps and Dow Jones Industrials blue chips closed above the psychological levels of 2,000 and 17,000, respectively — the first time since August — as well as above their 50-day simple moving averages. Although the Russell 2000 small cap index closed above its 50-day simple moving average, it remains more than 10% below its 52-week high set in June.

A big inspiration for bulls was the September FOMC meeting minutes that were released on Thursday afternoon showing that the Fed is concerned about persistently low inflation and the potential impact on the U.S. of the global economic slowdown. The Fed now doesn’t expect to reach its inflation goal of 2% before the end of 2018. Investors took this as a sign that the fed funds rate won’t be increased until 2016 — and likely it will be only a token one at that. The minutes also indicated that the Fed was further from approving a rate hike in September than had been broadly assumed, given the formidable global headwinds led by slowing growth in China and all of the broad implications of that, including falling demand for everything from commodities to Apple (AAPL) products.

Now we start to hear the Q3 corporate earnings reports, although investors are more interested in forward guidance than actual performance during the prior quarter. According to S&P Capital IQ, S&P 500 companies are expected to post negative revenue growth of -1.5% versus 3Q2014 (the third straight quarterly decline), primarily due to the strong dollar, and negative earnings growth of -5.3%, the first such decline since 3Q2009. However, excluding the Energy sector’s massive -66% earnings contraction, overall earnings growth for the others would be a respectable +2.7%. 

No doubt, this market has been hard to read and even harder to trade. Certainly it has been news-driven to a large extent. Moreover, we have seen sort of an upside-down market lately in which the former leaders (like biotech) have been taken to the woodshed while the former laggards (like Energy and Materials) have been strong, all of which is the opposite of what our fundamentals-based and quality-oriented quant models have been suggesting (see sector rankings below). Such events are certainly not uncommon. It is largely driven by short-covering on the lower-quality stuff and profit-taking/protection on the higher-quality.

Such is the case with the dominant biotechs/biopharmas, many of which still sport low forward P/Es but have been the target of some posturing politicians in this election cycle who noticed that a populist message about drug pricing was resonating, thus creating uncertainty in the minds of investors — even though nothing concrete has changed in the company’s fundamentals. Sabrient-favorite Valeant Pharmaceuticals (VRX) is a case in point. This carnage among the money-making biotechs was the “last shoe to drop” so to speak in this broad market correction that essentially began in late-June. ConvergEx pointed out last week that among biotechs, stock performance this year has been inversely-correlated to profitability. But we believe investor rationality will soon return to this important market segment — this is definitely a case of, if you liked them at the higher valuation then you should love them at these lower valuations.