Consolidation Continues as Impressive Earnings Meet Virus Fears

By Marc Chaikin, Founder Chaikin Analytics

By Marc Chaikin, Founder Chaikin Analytics

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Key Points

 

  • Positive Earnings Reports Overshadowed by Coronavirus Concerns

  • Weak Economic Reports from Manufacturing Sector Boost Bonds

  • 10-Year Treasury Yield Drops to 1.5% as Yield Curve Flattens

  • Small Caps Experience Brunt of the Selling…IWM Down 6% From Peak

  • Recession Bears Back as Weak Chicago PMI Report Roils Industrials

  • However, Fed Says QE Liquidity Infusions to Continue Though April

  • For 11 Years Stocks Have Rallied When Fed is Adding Liquidity

  • Tech Earnings Blow Through Estimates…AAPL, AMZN, MSFT & TSLA

  • Past Virus Epidemics Saw Sharp Bounce Back When Contained

  • Every Epidemic is Different so…

  • Traders Should Tighten Stops…Investors Look for Buying Opportunities

The S&P 500 Index closed on Friday at 3,225.52, down 2.13 % on the week. The positive impact of 4th quarter earnings surprises and bullish forward looking guidance took a back seat to concerns over the impact of the spreading Coronavirus on the Chinese economy and renewed fears of a recession based on a weak Chicago PMI reading. This week we have critical economic reports as the Institute of Supply Management releases its manufacturing and service sector indices. Friday will also bring us the key January employment report.

Spending patterns and confidence surveys still reflect a strong consumer economy which is driving the stock market higher. AAPL, AMZN and MSFT are examples of the companies benefiting from a strong consumer. Although the headlines suggest otherwise, the economy is still in a “goldilocks” uptrend and to reiterate what we have said for months, as long as the intermediate technical uptrend is intact we will remain bullish. Two key levels are now at 3,190 and 3,000. While a 335 point drop to 3,000 looks dire, it would still be in the very normal 6 -10% pullback range.

Investors will be bombarded with dire forecasts of a recession and a bear market if the S&P 500 Index drops below 3,190. Resist the temptation to panic with the crowd and stick to your plan for now. 

The most important news of the week for me wasn’t the Coronavirus headlines, some of which were flat out wrong, the very weak manufacturing reports or Bernie Sanders surging in Iowa, but rather the Federal Reserve Board’s statement after their Open Market Committee meeting. Fed Chair Jerome Powell clearly stated the Fed’s intention to stimulate the economy, in order to push up the inflation rate, currently at 1.6% on their favored PCE Inflation Index and below the Fed’s target of 2%.

Of equal importance was Powell’s commitment to continue to supply liquidity to the overnight repo market through the April tax period. This is quantitative easing (QE) plain and simple. So it’s important to know that during this 11 year bull market, stocks have gone up when the Fed has engaged in QE.

Thus we remain bullish on strong stocks in strong sectors and industry groups.

Our award winning ETF Power Gauge rating works particularly well in identifying the most promising sector and industry group ETFs. These strong ETFs are where the stocks with the best potential live.

Look for buying opportunities in the weeks ahead on emotional selling related to a possible Coronavirus epidemic. 

S&P 500 Index Technical Picture

The S&P 500 Index broke its first line of support last week when it closed below its 21-day average price. Even as earnings reports confirmed the strength in technology and health care stocks and a relatively strong consumer sector, fear oriented headlines about the Coronavirus and soft economic reports in the manufacturing segment of the economy, contributed to lower prices.

After a very strong start the S&P 500 Index finished the month of January lower courtesy of Friday’s steep decline. Stocks are down 3.3% from the record highs set in January with a number of concerns now front and center in the financial headlines.  There has been a shift to neutral in our technical indicators. On the plus side is the current oversold condition in the SPY with Chaikin Money Flow solidly positive. While this typically leads to a short-term rally, last Friday’s high volume decline to a new pullback low suggests lower prices ahead, even if we get a turnaround Tuesday. The percentage of stocks above their respective 50-day averages is also oversold for the first time since October.

In our webinars we use this chart from Ned Davis Research to show how commonplace pullbacks are and emphasize that pullbacks and volatility are usually buying opportunities. 79 pullbacks of 5 – 10% since 1945 have averaged 6.6%, 1 month in length and most important have recovered to new highs with a month of the bottom.

With the stock market not yet in the 5 – 10 % pullback range my expectation is for further weakness in the short-term taking the pullback into the 6 – 10 % area. A 6% decline would take the market down to 3,135 which would mean a break of psychological support at 3,200. A 10% decline would take the S&P 500 Index down to the closely followed  200-day average at 3,000.

What we would ideally like to see as a bottom is formed is more than a whiff of fear in the market. The CNN Fear and Greed Index, which is comprised of 7 sentiment indicators, is currently at a relatively neutral reading of 44 after reflecting a psychology of Greed over the past 2 months.  We would like to see this Index down to a very Fearful level under 10 as a bottom is being formed.

As noted above, the Fed was clear that they would continue to provide liquidity to the overnight repo market. Throughout this 11-year bull market, stocks have rallied when the Fed is providing Quantitative Easing, which they have been doing since October.

With 4th quarter earnings and forward company guidance strong, a decline of 6-10% to 3,000 – 3,135 would be an attractive buying opportunity.

Intermediate-term support is at 3,135, while resistance is at 3,285 – 3,300.

Intraday Chart of the S&P 500 Index

Chart Courtesy of StockCharts.com

Stocks gapped down sharply on Monday morning, a decline that rarely reverses that day. On Tuesday and Wednesday the S&P 500 Index keyed off very strong earnings results from technology companies like Apple (AAPL) and Microsoft (MSFT) and rallied back to the previous week’s close of 3,295. 

Thursday saw a sharp, late day, upside intraday reversal of 1 ½% but renewed concerns over the Coronavirus and a very weak Chicago Purchasing Managers Index report on Friday took the Index down 1.8% on ultra-high volume in the SPY ETF.

Although our OB/OS Indicator is once again oversold, the very high volume on Friday suggests lower lows, even if we see a bounce early in the week. Short-term support was broken on Friday and a key support level at 3,190 is now in play. For further analysis of likely price action going forward see the above technical comments on the S&P 500 Index

Short-term support is at 3,190 – 3,200, with resistance at 3,285 – 3,300.

Chaikin Screen of the Week

Stocks to Avoid / Sell on Rallies

We are looking for higher highs in the S&P 500 Index once the Coronavirus fears subside. Buying opportunities abound in strong sectors and industry groups. Of equal importance is knowing what stocks not to buy, or to sell on rallies.

I have screened for large cap stocks with Bearish or Neutral Minus Power Gauge ratings with relatively weak free cash flow and analysts lowering their earnings estimates.

This week’s screen uses the following criteria:

  • Universe: S&P 500 Index
  • Power Gauge Rating: Very bearish, Bearish or Neutral Minus
  • Free Cash Flow: Bearish
  • Analyst Estimate Trend: Bearish

24 stocks in the S&P 500 Index passed the screen including stocks that have recently reported negatively. Many of these companies are in the weak Energy and Industrial sectors, highlighting the value of a top down approach to stock selection.

Power Bar Differentials for the Major Indices

The Power Bars for all 3 major indices remain in positive territory, although there was major deterioration last week, except in the technology stocks, as the stock market went into defensive mode. The worst reading is now the bull/bear ratio for the SPY, which at 106/103 is indicating a big divide between the strong technology and utility stocks and the weak energy and industrial sectors.

The implications of this split are now showing up in a bearish technical indicator called the Hindenburg Omen, but that pattern is often early or wrong. We will monitor the Power Bar for the SPY as the stock market probes for a bottom in the weeks ahead.

The Power Bar ratio for the Russell 2000 small cap Index took another tumble last week as small caps were unloaded in the risk-off response to the Coronavirus headlines and sharply lower interest rates.

ETF Sector Update

There are 5 sectors with bullish Power Bar ratios all of which are stronger than the bull/bear ratio of S&P 500 Index. The Utilities, Technology, Health Care, Financial, and Communication Services Sectors, which have been leading the market higher, have seen consistently strong Power Bar ratios and are the best place to look for buying opportunities as the Coronavirus situation plays out. 

This persistent Power Bar strength at the Sector level shows the value of our aggregation of the fundamental potential in a Sector or Industry groups as defined by the Chaikin Power Gauge rating.

Avoid the temptation to bottom fish in Sectors with bearish Power Bar ratios like Energy and Materials.

Generate a Portfolio Health Check on any of the Select SPDR Sector ETFs, and see which stocks within the sector have bullish or bearish Power Gauge ratings. The stocks in the bottom left of the Power Grid are sale candidates on rallies.

The Chaikin Power Gauge ratings are a consistent source of bullish ideas. Strong stocks in strong industry groups based on the ETF Power Gauge rating tend to outperform the market. In addition to across the board strength in the Industry Groups that make up the Technology and Health Care Sectors, Homebuilders, Aerospace & Defense and Capital Markets are attractive.

This Week’s Earnings Reports

There were a slew of positive earnings surprises last week, many of which propelled stocks higher in a down week for the market. Apple (AAPL), Amazon (AMZN), Microsoft (MSFT), General Electric (GE), Lam Research (LRCX) and MSCI Corp (MSCI) all reported stellar 4th quarter earnings. On the downside, Facebook (FB) disappointed and guided lower while the biggest negative surprises were in the Industrial sector where Boeing (BA), Caterpillar (CAT), DuPont (DD) Celanese (CE), 3M Corp (MMM) and United Parcel (UPS) disappointed and were punished in a nervous market.

This week Alphabet (GOOGL), Fortinet (FTNT), Disney (DIS), Cardinal Health (CAH) and a gaggle of semiconductor stocks such as Microchip (MCHP), KLA CORP (KLAC) and Qualcomm (QCOM) report.

The following stocks saw their Power Gauge Ratings turn Bullish or Bearish ahead of this week’s earnings reports.

Be sure to run a Portfolio Health Check on your “My Stocks” list in Chaikin Analytics, or check our Upcoming Earnings Ideas Hotlist, to find additional companies that report earnings this week and when they’re reporting.

Last Week’s Bullish Stock of the Week: Bristol-Myers Squibb (BMY) traded down to our buy point of $62.50 on Friday and closed the week at $62.95 down 1.9 % on the week. BMY continues to remain an attractive purchase at current levels, well supported by a 2.86 % dividend yield.

Bullish Stock of the Week: Centene Corp (CNC) – $62.80

Centene has a bullish Chaikin Power Gauge Rating. The stock has been outperforming the market since mid-November. In selling off from a recent high $68.08 to $62.80 CNC has triggered an Oversold Buy Signal in Chaikin Analytics. The surging poll numbers for Bernie Sanders in the Iowa presidential primary tomorrow may have accelerated the pullback in CNC, as Sanders is considered to be unfriendly, at best, to health care providers.

Centene reports earnings before the opening on Tuesday after Monday’s Iowa caucuses. Analysts are estimating EPS of $4.42 for 2019 vs. $2.31 in 2018 with further gains to $4.80 in 2020.

CNC is a diversified healthcare company that has profitably navigated the political waters in the Medicaid/Medicare space. Management’s expertise in profitably providing healthcare services to the underinsured and uninsured individual is reflecting in an average analyst price target of $79.87 according to TipRanks.

With the uncertainty of the Iowa Caucus results and Tuesday’s upcoming earnings report we would recommend buying CNC on any further weakness down to the $58 – $60 area in the near term.

Our Research Checklist for Centene shows all systems go:

This Week’s Strongest Industries

This Week’s Weakest Industries

Disclaimer

Disclaimer: Chaikin Analytics LLC is not registered as a securities broker-dealer or advisor either with the U.S. Securities and Exchange Commission or with any state securities regulatory authority. Chaikin Analytics does not recommend the purchase of any stock or advise on the suitability of any trade. The information presented is generic in nature and is not to be construed as an endorsement, recommendation, advice or any offer or solicitation to buy or sell securities of any kind, but solely as information requiring further research as to suitability, accuracy and appropriateness. Users bear sole responsibility for their own stock research and decisions. Read the entire at www.chaikinanalytics.com/disclaimer

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