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What the Market Wants: Where’s the Next Support?

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Courtesy of David Brown, Chief Market Strategist, Sabrient

Today the S&P 500 Index dropped 32 points and plunged through its major support level as if it wasn’t even there.   Support at 1120 has held firm on many occasions in the past two months—the latest being last Friday—but today the Index landed at 1099, which is more than 20 points below its previous support.  It’s no comfort that the next solid support is at least 40 points lower.

The drop is clearly related to the lack of progress with the Greece bailout.  Despite all the promises we’ve heard, investors still fear the country will be allowed to fail (but I doubt that).   Adding to investor worries are the problems with China’s economy.  Some positive readings from our own economic reports, which we’ve all been waiting for, failed to soften the landing.

Positive reports included today’s ISM Manufacturing Index (up +1% from last month) and construction spending (1.6% higher than expected and 2.8% higher than the previous month).   These on the heels of last week’s happy news from  the Chicago PMI, indicating sharp improvement in business conditions in the Chicago area, and the easing of consumer pessimism, as measured by the Reuter’s/University of Michigan Consumer Sentiment Index.  Moreover, initial jobless claims dropped sharply last week to 391,000, falling below 400K for the first time in several weeks.  Even the third revision of GDP was up, rather than down, albeit only 0.1% more than expected.

Under other conditions, these numbers might have buoyed the market, but not today.  So much for timing.

Market Stats. Last week, the S&P 500 Index ended the week just about where it began, but the flight-to-safety gave Large-cap Value almost a +1% gain.  Anything to do with growth or small caps was negative, although the numbers weren’t nearly as bad as the week before.

Financials led the sector performance last week, rising from the ashes for a +1.5% gain.  (The sector gave it all back today, along with another 3%, falling -4.5%.)  The traditional flight-to-safety sectors, Health Care and Public Utilities, were both up around +1%, while Basic Industries, Consumer Services, and Technology were all down -2% or more.

Until the European situation is settled, we will continue to cast a skeptical eye on our forward-looking SectorCast.  Basic Industries is the highest ranked, due to a much lower than normal P/E ratio, but no one is betting on Basic Industries until we see some sign of global growth.

One encouraging note comes from the stats on our top-ranked 100 stocks.  On May 2, 2011, the group had a projected P/E ratio of 8.2.  Last week it declined almost 30%, to 6.06, while the market fell somewhat less than 20%.  What this means is, for those top 100 stocks, earnings forecasts for the year have increased significantly, bringing the projected P/E close to its February 2009 low of 5.25. What this means for you, the investors, is that valuations are attractive.

Another factor we consider for our top-ranked stocks is “net revisers” (the difference between the number of analysts revising upward for the current year versus the number revising downward for current year).  Last week this number improved from 3.5 to 4.9.   Another factor is a valuation score, which compares the current quarter’s projected earnings (assuming they are met) with the same quarter a year ago and its stock price.  This score, 9.95, is the highest it has been since we started keeping these stats in March 2009, when it was 2.34.

These stats tell us that when the uncertainty is removed (assuming it ever is) the market could be in for a fairly sharp gain.  Unfortunately, we won’t know when that will happen. Even if Greece is actually resolved, our own government is on a fairly short deadline to settle the spending cut/tax loophole issues.  Based on recent behavior, we have no reason to believe that Congress will get that done before the November deadline.

Nevertheless, there are some attractively priced stocks out there, so we would suggest investing in flight-to-safety sectors in stocks with very attractive valuations, such as the four below.  Also, we continue to recommend hedging—by shorting FXE (Rydex Currency Shares Euro Currency Trust), which tracks the euro’s value against the dollar, and/or going long on the VXX (the iPath S&P 500 Short-Term Futures ETN or “fear index”).

4 Stock Ideas for this Market

This week, I started with the Undervalued Large Cap Growth preset search in MyStockFinder (http://MyStockFinder.com). I also included Buys (in addition to Strong Buys) and slightly up-weighted  Group Strength. Here are four stock ideas that look intriguing in this shaky market:

Agilent Technologies Inc. (A) – Technology
MedcoHealth Solutions Inc. (MHS) – Health Care
Coach Inc. (COH) – Consumer Non-durables
EQT Corporation (EQT) – Utilities

Until next week,

David Brown


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