Stock of the Week

First quarter and outlook for Q2

May 1st 2017

Sell in May and Go Away

If 2016 was boring up until the Presidential election, 2017 has been pretty easy for the bulls, at least in the major indexes. It wasn't until March 21st when the S&P 500 finally had a 1% decline, the first such decline since October 11th of last year or 110 trading sessions, ending its longest streak of calmness since 1995. Following the March 21st decline, the major averages resumed their climb with the S&P 500 finishing the first quarter up 6%. The Dow Jones rose 5% while the Nasdaq led all major US averages up 10%. The Russell 2000 lagged all the other major averages up just 2.5%. To no one's surprise, the tech sector led all sectors through the first quarter rising 12% year to date. Consumer discretion (a.k.a Amazon) and healthcare tied for second up 8%. Healthcare was the worst performing sector in 2016, funny how that happens. The worst performing sectors through the first quarter were energy and telecom.

 April and the  first quarter earnings did not disappoint with a majority of S&P 500 companies posting better than expected earnings, posting double-digit earnings growth for the first time since 2011. The major averages rose another 1% to 2% for April, but now that the calendar has turned to May, the question is, will the stock market rally continue?

The fundamentals are very good for a number of large cap companies, the cash hoard and cash flow for the S&P 500 continues to grow so the question boils down to valuations. This market is not cheap with the forward 12-month P/E ratio for the S&P 500 at around 17or 18. The average P/E ratio is above the 5-year average of 15.1 and the 10-year average of 14. My favorite indicator, the VIX index made a new low of $9.90 today below $10 for the first time since 2007. The VIX is a fear gauge and a contrarian indicator. The lower it goes the more susceptible the major averages are to a correction. The last time the VIX was below $10, was January and February of 2007. Following that the VIX climbed to $90 over the next year and a half through the height of the financial crisis.

I'm not expecting another bear market, but a return to normalcy would be more likely with more down days to come and a correction of 5% to 10%. There is the old adage, sell in May and go away. Following a typical strong start to the year, the major averages struggle over the next six months from May through October. Over the last 20 years, the S&P 500 has posted negative returns from the end of April through the end of August with 55% of the trading days in the red.

A VIX below $10 would be a good contrarian indicator that more down days and a little more fear in the markets may be on the horizon.

Having said that, the top tech stocks will have a lot to say about where the major averages will go. The top four positions in the S&P 500 are tech-Apple, Microsoft, Amazon, Facebook. Exxon Mobil is now only the fifth largest S&P 500 component. Facebook and Apple report earnings this week.  Tech in general looks pretty fully valued.

 The financials have performed well in the last six months. They should hold up well and may become a defensive sector in the next correction. Investment banks like Morgan Stanley (MS) and Goldman Sachs (GS) still look attractively valued.

My favorite sector for the New Year remains healthcare or in particular, biotech. Healthcare was the worst performing sector for 2016 and only one of two sectors that closed in the red for the year. Its true drug pricing has gotten out of control, but the sector as a whole is not expensive. Similar to last year, Celgene (CELG) remains my top picks. The company is projecting 20% annual growth for the next four years thanks to a plethora of drugs in the pipeline. Celgene has at least 18 late-stage clinical trials by 2018.with the potential for 50 new product approvals through 2025. Currently the stock trades for 16 times earnings, but only 13 times 2018 numbers. An investor with a long term horizon should be rewarded with 50% upside in the next year or two and 100% upside in the next three to four years. Other biotechs to look at include Biogen (BIIB), Allergan (AGN) and Amgen (AMGN).

If we get a good correction in the next six months, defensive sectors like Consumer Staples, Telecom and Utilities may perk up.

It's been an easy run to start the year. We'll see what the next six months looks like.