A Stock Picker's Market

Major Moves

Alphabet Inc.'s (GOOGL) earnings are out this afternoon, and the results look lower than expected. Should investors be worried about growth? I think there are two reasons to be optimistic despite the initial reaction to Alphabet's report: consumer spending and breadth within the tech and software groups.

I have been saying for a while now that, if there is one part of the U.S. economy where things are going very well, it's consumer spending. Because consumption is more than 70% of the economy, a healthy consumer is a good thing for higher prices in the stock market as well.

The Bureau of Economic Analysis (BEA) released February's and March's consumption numbers (February's had been delayed as government agencies caught up from the shutdown). The month-over-month increase for March was 0.9%, which is a very good reading. Even adjusting for a surprisingly low consumption numbers in December, the trend of consumer spending is comfortably positive.

Consumer spending is clearly a good thing for retail and services stocks, and it also has a positive impact on the technology sector. So far this year, software companies have been the best performing group within the best performing sector. Although much of the growth in the group can be attributed to stocks like Microsoft Corporation (MSFT) and Adobe Inc. (ADBE), the outperformance of smaller stocks in the rest of the sector has been similar.

For example, within the application software sector, stocks with a market capitalization between $500 million and $10 billion (small to mid-cap) have had an average growth rate of 32% compared to the S&P 500's growth of 17%.

In my experience, looking at the underlying breadth of a sector's or group's performance is a good way to evaluate the likely strength of a breakout. If a rally is driven by very few large performers, the potential for a whipsaw or bearish reversal is much more likely. In the following chart, you can see the recent breakout in the application software group through the iShares Tech-Software Sector ETF (IGV).

Performance of the iShares Tech-Software Sector ETF (IGV)

S&P 500

The strong performance in tech, banking and retail has driven the S&P 500 to new intra-day highs today. A strong start to the week is good because the next few days could be more choppy than usual as European and Chinese markets close on May 1 for the Labor Day holiday.

Unfortunately, although the S&P 500 has also broken out of its own rising wedge consolidation pattern, breadth hasn't been as strong across the rest of the market. Small caps are still lagging on average, and transportation stocks had a rough time last week after being rejected from short-term resistance.

Market conditions like this are often referred to as a "stock picker's market" – the common assumption is that it is easier to outperform the indexes by selecting stocks with growth characteristics while the major indexes are dragged by underperforming groups. This is a debated concept, but in general, I think it makes sense to take advantage of periods like this by focusing on sectors with positive breadth and proven short-term growth.

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Performance of the S&P 500 Index

Risk Indicators – Emerging Markets

From a risk perspective, there have been some notable improvements. The weakness in high-yield bonds I discussed in an early Chart Advisor Issue last week has dissipated, and volatility expectations remain relatively low.

The Treasury yield curve remains a frustration for bulls, but if negotiations between the U.S. and China's trade delegations go well, investors may start to price in more short-term growth prospects into interest rates. Trade discussions are scheduled to continue Tuesday.

At this point, I think the most pertinent issue affecting the level of risk in the market is the lack of breadth in many sectors, as I mentioned above, and internationally. For example, although the S&P 500 is flirting with new highs, almost all major international indexes are still well below the 2018 highs or have continued to decline.

As you can see in the following chart, emerging markets (as represented by the iShares Emerging Market ETF [EEM]) have failed to make any headway after being rejected at resistance on the 17th. If this trend continues, the potential for the S&P 500's rally starts to fade as well.

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Performance of the iShares Emerging Market ETF (EEM)

Bottom Line – A Big Week for Earnings and Economic Data

The market got off to a big start today with earnings results from Alphabet after the market closed and consumption numbers from the Bureau of Economic Analysis before the open. Traders will be anxiously looking forward to the earnings news from Apple Inc. (AAPL) tomorrow after the market closes and whether Mastercard Incorporated (MA) can confirm the health of the U.S. consumer when it releases tomorrow morning. Despite the May 1 Labor Day holiday, it should be a busy week for data.

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