Monday, July 12, 2010

Before Earnings: A Sector Analysis of Stocks

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Second quarter earnings season begins this week and the bulls are hopeful that good earnings will turn the market around. While the Dow and S&P 500 have given bear market signals, not all nine economic sectors have turned bearish and this provides some insight as to where the market is most hopeful for positive reports.

The two sectors of the market that have remained technically strongest are the Industrials (XLI) and Consumer Discretionary (XLY).  A third sector, Utilities (XLU), was the first to turn bearish at the end of May, but its price moved above the 50-day and 200-day simple moving averages on Friday. It needs to hold at that level in order for the chart to regain a bullish tone. Utilities are highly interest rate sensitive and the big drop in interest rates in the last three months should be bullish for them. While dropping interest rates indicate a weakening economy, Industrials and Consumer Discretionary doing well indicate a relatively strong economy. Good industrial earnings may make some sense at this point, but good consumer discretionary earnings do not.

The charts for Basic Materials (XLB) and Energy (XLE) both became bearish in mid-June. Since their products are inputs for industrial companies, profits for industrials could improve because their costs are decreasing. Technology (XLK) company profits though are not that sensitive to lower raw material costs and this sector turned bearish in early July.

The two sectors that tend to be relatively recession proof, Health Care (XLV) and Consumer Staples (XLP) turned bearish in early June and early July respectively. Both had major sell offs during the Credit Crisis though - a major downturn will take everything with it. Health Care stocks are possibly more affected by recent legislation than other factors, so it is difficult to say much about them at the moment. Consumer Staples though should not be bearish, while Consumer Discretionary is bullish. In a good economy, staples will rise more slowly than the discretionary stocks, but they will both be bullish.  The economy generally has to be very troubled for a significant downturn in Consumer Staples.

The remaining sector, Financials (XLF), turned bearish in early July. This is taking place despite an array of government programs to pump money into the banking system. Government actions are so predominant for this sector, that a downturn is difficult even if the economy is deteriorating rapidly.

It will be interesting to see how bullish or bearish each sector looks after earnings season is over. In 2008, Consumer Staples, Basic Materials and Utilities had charts that were at first bearish, but then turned bullish during the spring or summer before the complete collapse in the fall. Industrials appeared to briefly turn bullish at the same time as well. Energy didn't turn bearish at all until August. Only Financials, Consumer Discretionary and Technology were consistently bearish all year. The worst possible economic and market conditions are generally necessary for all sectors to turn bearish at the same time.

Disclosure: No positions

Daryl Montgomery
Organizer, New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

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