foxex: The Year of the Pig (Beware of Hogs)

Chart Advisor | Investopedia

Focus on the Price

By John Jagerson, CFA, CMT

Monday, February 04, 2019

1. Hidden risks in some surprising sectors

2. Alphabet's report bodes well for tech and consumer stocks

3. Sentiment still improving in the Forex

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Major Moves

As I mentioned in last Friday's Chart Advisor newsletter, banks and stock markets in China and much of Asia will be closed for the Spring Festival or Lunar New Year holiday. This week marks the beginning of the Year of the Pig. This reminds me of the stock traders' adage "pigs get fed, and hogs get slaughtered." The saying is supposed to make the point that profit-seeking investors (pigs) can be successful over the long-term, but overleveraged, inconsistent traders (hogs) will implode.

Evaluating the current market environment for signs that the hogs are getting out of control is a good exercise. Analysts expectations for earnings in the first quarter of 2019 are near 0% which could be another underestimate, but it certainly indicates a situation where appropriate judgment and discernment is important.

An area of concern for me right now, is valuations in the "defensive sectors". For example, I ran an analysis today of the 50 largest stocks in the US utilities sector and the average P/E ratio was 27, which is up from 23 in 2014. To put that in perspective, the average P/E ratio across the S&P 500 has recently fallen to 20.85. Does it make sense that utilities should be one of the most highly valued sectors in the market?

For most sectors, a high P/E ratio is a function of growth expectations. In other words, sectors that are growing tend to have high earnings multiples because profits are expected to rise quickly in the future, therefore, in most cases, a high P/E ratio is not particularly worrisome. However, high growth rates and utilities do not usually go together. In my opinion, investors should be as picky as possible when considering the value of individual sectors to avoid the hogs. As you can see in the following chart of the SPDR Utilities ETF (XLU), there is a key pivot level at $55 per share which, if valuations are already too extended, may be setting investors up for failure.

Alphabet, Inc. (GOOGL)

The counterpoint to the defensive sectors, which seem overvalued, are the other groups that have likely been oversold during the market decline at the end of 2018. Technology is one of those sectors that seems likely still undervalued. For example, Alphabet, Inc.'s (GOOGL) earnings were released this afternoon and were above expectations ($12.77 vs. $10.86 estimated) which is another positive surprise in a sector that suffered some of the worst selling during the previous market decline.

Alphabet, Inc (GOOGL) is an important stock because most of its revenue and profitability is derived from advertising. If the consumer and business economies are doing well, then advertising rates are strong and GOOGL's earnings will be positive. This is often one of the first places we can detect underlying weakness in the economy if advertising spending rates are flat or negative.

The bottom line is that even if GOOGL's is trading lower after the close on rising costs and lower margins (see chart below) the top and bottom line numbers should be supportive for the sector. I wouldn't be surprised to see prices rise again in tomorrow's session once investors have had a chance to digest the data.

Read more:

Average PE Ratio in Utilities Sector

What are Earnings?

What is Sector Analysis?

Risk Indicators - The Week Ahead

Most risk indicators are still signaling that there is little cause for concern in the near term across the broader market indexes. The bond, gold, small-cap, and volatility indexes were all still headed the right direction today as the S&P 500 rallied. I was further encouraged by the improvement in the positioning of traders in the currency market. Although it isn't always a topic for financial headlines, safe haven currencies like the Japanese yen usually fall when risk appetite is rising. Although the yen didn't decline very much in January, it is just starting to inch beyond short-term technical levels that should be supportive for higher stock prices.

Although this can be confusing for non-Forex traders, the chart below illustrates the amount the yen has fallen in value over the last two trading days against the US dollar. When the chart is rising, that means it costs more weaker-yen to "buy" a dollar. A rising USD/JPY exchange rate is usually correlated with improving stock prices and a falling USD/JPY can provide early warning signs of weakness.

Read more:

Forex Trading for Beginners

Where Have All the Bears Gone?

Three Charts In Favor of Gold

Bottom line:

Bonds, stocks, and risk indicators seem to be pointing the right direction for additional gains in February. However, using discretion when evaluating the relative risk of some traditionally "defensive" sectors is likely to be important for investors trying to maximize their profits and avoid the hogs.

Read more:

What is the USD/JPY Exchange Rate?

Get Started as a Successful Investor

Alphabet Inc.'s (GOOGL) Earnings Report