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Investment Strategy

The Stage is Set for a Strong Second Half

By Elliott H. Gue, on Aug. 14, 2015

The S&P 500 remains locked in a 100-point trading range between 2,050 and 2,150. But beneath this placid surface, a growing number of stocks have suffered significant pullbacks this year.

Although the S&P 500 has gained about 2 percent on the year, five of the 10 economic sectors represented in the index have posted losses and seven have lagged the broader index. Only the health care and consumer-discretionary sectors have outperformed the S&P 500 by a significant margin.

The S&P 500 sits only 3 percent off its May 20 high, but only 37 percent of the stocks listed on the New York Stock Exchange (NYSE) trade above their 200-day moving average, a technical indicator that identifies equities in an uptrend.

(Click graph to enlarge.)Third Article -- NYSE above 220-day moving avgThe last two times market leadership had narrowed to this extent—June 2012 and October 2014—the US equity market was in midst of a significant correction. In spring and summer 2012, the S&P 500 pulled back about 11 percent between April and June, hit by a flare-up in Europe’s sovereign-debt crisis and a soft patch in the US economy.

Last fall, plunging commodity prices and uncertainty surrounding US midterm elections catalyzed a 10 percent downturn in the S&P 500. Such deterioration in market breadth without a commensurate decline in the major market averages is an unusual phenomenon, likely caused by sector rotation.

The energy sector, for example, has suffered hard hits over the past month and a half as the market comes to grips with the reality that oil prices could suffer more downside in the near term and generally will remain lower for longer.

We’ve championed this view for some time, even when the short-lived rally last spring (in reality, an oversold bounce headed into a period of seasonal strength) seemingly validated wishful thinking for a V-shaped recovery in oil prices. (See Reading Oil’s Futures.)

Meanwhile, consumer-oriented stocks such as Wealth Builders Portfolio holdings Kroger (NYSE: KR) and Darden Restaurants (NYSE: DRI) have benefited from the wealth effect that falling energy prices have on consumers.

Narrowing market leadership and the breakdown of Apple (NSDQ: AAPL) and other high flyers create the potential for near-term downside in the S&P 500. However, the US stock market’s next major move likely will reflect the economy’s health and future prospects. The news on this front is far more favorable.

The Bloomberg US Economic Surprise Index, which quantifies how recent economic data points have measured up to analysts’ consensus estimates, has trended higher after extreme winter weather, distorted seasonal adjustments and a strike at West Coast ports resulted in a disappointing first half of 2015. In other words, economic data points have started to surprise to the upside after a challenging start to the year.

(Click graph to enlarge.)Third Article -- BBERG Economic Surprise Index

We expect strong consumer spending to drive US economic growth in the back half of 2015. Over the past three quarters, consumer spending has contributed about 200 basis points to US economic growth, compared with 1.5 percent over the same period in 2013-14 and 1.1 percent in 2012-13.

(Click graph to enlarge.)Third Article PCE GDP

Record US demand for gasoline this summer suggests that the holiday shopping season—a key component of fourth-quarter retail spending—could surprise to the upside in 2015. Our strategy will continue to take advantage of dips in the broader market to buy our favorite health care and consumer-discretionary stocks.

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