Value Rotation?

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It’s the height of earnings season and so far we have gotten a mixed picture. The market continues to bounce between a support and resistance range, we are waiting to see how the Ukraine situation plays out and lastly, we are not certain how and when the Fed’s monetary policy will change. The pre-market futures look flat and seem to be waiting, rather than clearly reflecting a general sign of optimism or pessimism. However, with stronger Dow Jones and S&P 500 vs. a weaker NDX and Russell, it seems that a value rotation could be in play.

Value Rotation?

I believe we are seeing a value rotation in the market and earnings can fuel that even further. One only has to look at the strength of the Dow Jones and S&P 500 relative to the weaker, tech heavy NDX and broader based RUT. If a value rotation is at play, earnings could bring more volatility to the market and further the spread between these indices.

Some big names have missed; Google, IBM, and JP Morgan. We are also drowning in GM news, which looks like it could be setting up for a massive class-action lawsuit and millions of cars being recalled.

Big Earnings Week

This is a big week with earnings in Apple, Netflix, Amazon, Facebook, CAT, GM, Visa, Ford and others. Will they report stories similar to those we have already seen? Pretty much the Western story is weaker top-line sales and any bottom line beats are coming from managing costs. The emerging markets are still the strongest growth area, but that growth may not be strong enough to offset domestic sluggishness. Part of the spin will certainly be to blame the late winter storms for much of the weaker first quarter; however, what are the 2nd quarter and full-year forecasts looking like? The first to report is Netflix, after the close.

Depending on how the earnings stories play out for the first quarter, I believe we could see a rotation into value companies and out of growth. We saw a huge rally and move into some IPO and tech stocks, which in some ways reminded me of the 1999 Dot.Com boom. Many of these companies had little revenue and ran at a negative burn rate, yet their P/E ratios were rocketing on forward expectations. Some of the companies are actually making some steps forward to justify the higher P/E ratio, such as Facebook – which had initially struggled with their ability to monetize their core offering. However, many others have still seen very weak actual revenue growth. The boom in the high-tech sector has, perhaps, gotten a little frothy.

Rotation at Play?

After the strong run in the equity markets, coupled with some changes in Fed monetary policy and other volatility, we could be seeing some initial rotations in to safer securities. Since Treasuries are not an option (paying little to nothing in yield), we could see a move into value and blue-chip stocks. These companies will have stronger earnings, dividends, steady growth, and less volatility. They are the commodity companies that will continue to see steady revenue flows regardless of economic conditions.

Some of that is seen in the recent earnings, as we saw Johnson & Johnson remain strong in a relatively weaker earnings cycle. If we see that story continue to play out we could see this rotation come sooner, rather than later. This is usually the first sign of a generally conservative attitude in the market and a reflection of larger concerns. If investors are not willing to take heavier positions in growth stocks, then they obviously have some broader economic concerns.

I have a feeling that this could be the instrumental week for earnings that will either drive optimism or concern. Let’s not forget that Yellen remains on the sidelines and her recent statements do sound more dovish. That could help boost a little confidence if the market knows she is keeping the printing press running full steam.

Support & Resistance

INDU 16,000 – 16,600
The Dow Jones has an inside trading range of 16,200 – 16,400. Resistance starts kicking in at 16,400 with some range up to 16,600. On the down side we see buying start around 16,200 and go all the way down to 16,000. This week’s earnings can certainly push us to those outside ranges (above 16,400 or below 16,200) so I would set my alerts at 16,000 and 16,600, in which I would expect to see any wider break-out possibilities.

NDX 3400 – 3600
The NDX has been in a clear downward trend since March 1st, with lower lows and lower highs, coupled with some intra-day volatility. Google missed expectations and with Apple this week, this index could see some big volatility. Apple is an overweight, so mark the 3400 range for support. If Apple drops hard we could break below the 3400 level, which could induce some panic selling.

SPX 1800 – 1900
This is certainly the broad-range that needs to be broken out of to see any trend. The inside range is in the 1840 – 1880 area. Actually, we see resistance kicking in as early as 1875. The VIX has come down after the recent rally to the 13-14 range, which again doesn’t really reflect a bullish or bearish market.  In this range the VIX is pricing the uncertainty of whether we will see a bullish break-out, or a bearish sell-off. I would argue that VIX is not sure how the price volatility at this point.

RUT 1100 – 1160
The RUT has also been in a downward trend with lower lows and lower highs. I would look at 1100 as critical support for the broader market and I think we need to see a solid close above 1160 before we can build any confidence that the market is seeing stronger in-flows.

I expect this week’s earning to certainly test supports and resistances in the market. The question is, do we see the market break-out of these trading ranges? The S&P 500 and Dow Jones certainly seem a lot more healthier than the broader based Russell or the tech heavy NDX. I believe this is a sign that we are seeing moves into value stocks like J&J as investors exit some high growth stocks like Google.

Remember, at the end of the day there is some level of mean-reversion. You can certainly have sector / value rotation within the market, but net order flow drives the market higher or lower. Either the SPX and INDU will correct to the RUT or the RUT will correct to the SPX and INDU. The RUT tends to be a better broad-based indicator because it is not subject to over-weights dragging the index around, and I believe it is a better indicator of broad-based order flow into or out-of the market.

Today’s Earnings:

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