Stock of the Week

Mid Year Review

July 3rd 2017

Mid Year Review.

A heck of a start to 2017. The Dow and S&P 500 are up 8% each with an impressive two month rally right out of the gates. Since March 1st the two averages have pretty much gone sideways. The Nasdaq did not stop, rallying past March first now up 14% year to date thanks to the tech sector. The techs have had a banner first half of the year rallying 20%, now accounting for 25% of the S&P 500 including the top four positions. The techs were led by the FAANG stocks like Facebook Apple, Amazon, Netflix and Google. In fact the market caps for Apple, Amazon, Facebook, Microsoft and Google now add up to $3 trillion. That's a lot of money to keep those stocks riding these highs. In fact, Facebook expectations are for $50 billion in sales next year trading for 9 times sales (tech bubble valuation) and 25 times earnings. If earnings or sales slow, Facebook could be in for a big correction.

Besides the performance of the tech sector, the lack of volatility has been a major theme for the first half of the year. The maximum pullback for the S&P 500 over the last six months never exceeded 2.8%, which makes this the second smallest first-half drawdown in 89 years. Another great indicator for the lack of volatility has been the VIX index for fear gauge. In the past 20 years, the VIX volatility index has closed lower than 10 on a total of 11 days, and seven of those were in the past month. Besides this year, the VIX had not closed below 10 since 2007.

With the end of the quarter and end of the first six months, it's not uncommon to see money managers reallocate money from the sectors that have performed well to the sectors that have underperformed. Last year at this time, the two worst performing sectors were healthcare and financials. Since then, the two sectors are up 14% and 28% respectively. Last year's best sector, Energy rose 27%, but is by far the worst performing sector year to date down 13%.

I would not look to energy to make much of a rebound in the second half of the year. Obviously it will depend on the price of oil and whether OPEC can get productions lower.

Other sectors that have underperformed are telecom and consumer staples, two defensive sectors. These two sectors may be good bets for the second half of the year particularly since we're overdue for a correction and more volatility or basically, a return to the norm. The world seems to be moving away from the easy money that helped propel this eight-year bull market. Peak quantitative easing may be  behind us. That may be good news for the defensive telecom and consumer staple space.

The financials have performed well, but the sector should hold up in the second half of the year thanks to positive Fed stress test results that will allow the banks to up their dividends and boost their share buybacks. Citigroup (C ) and JP Morgan (JPM) have both added over $15 billion to their buyback plans while the dividends are getting more completive with the S&P 500. Bank of America (BAC) is another popular bank stock with a new $12 billion buyback plan. Goldman Sachs (GS) is relatively cheap trading for 10 times earnings, but not much of a dividend. Speaking of dividends, Blackstone (BX) has one of the best dividend yields now at 8% trading for 10 times earnings.

One stock to watch in the second half of the year is Tesla (TSLA). The company's 15-year-quest to reach mainstream consumers with a smaller, more affordable $35,000 electric car will happen this month. Tesla plans to produce 100 Model 3 cars in August, 1500 in September and ramping up to 20,000 a month in December. Tesla reported last spring that 373,000 people had placed $1,000 deposits for the vehicle. If these numbers are accurate, the Model 3 will produce $13 billion in sales for Tesla or a double in company revenue in the next year and a half.  The stock is already up 80% year to date, so much of the good news has been priced in. The big question going forward for Tesla is profitability.  If Tesla can make a profitable Model 3 and future SUV models, then the stock can continue to grow. It will be a fun story to watch.

Buckle up. The second half of the year could be fun.