Zacks October Market Strategy

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The following is an excerpt from John Blank's latest Zacks Market Strategy report. To access the full PDF, click here .

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The September jobs report looked weak across the board. This poor report raised serious questions about whether the Fed will raise rates at all in 2015.

Two months after a sudden correction, what's my current message?

Q3 earnings season is close and will clarify. In the interim, stocks trade on a mix of shorting (bearish) and short covering (bullish), and bargain hunting (bullish) and profit-taking (bearish). Q3 stock and company narratives will add weight to all of these cases. The major stock market indexes will show us the mixture.

As I wrote last month, the "Short Global Growth" event is at the end of a third leg down.

Short rules were changed meaningfully in 2006. Added to that, there is an aggressive search for a set of negative scenarios to bring a major short trade into long-short hedge funds that are funded with 100s of billions of dollars. The capital is fed to them by the big endowments, pension funds and sovereign wealth funds. Stock markets feel heavy weight from these informed, concentrated short calls.

The first leg of the stock selling and shorting hit went Mario Draghi got bearish on Europe in the middle of 2014.

The second leg of this short play came in October 2014, when the Fed ended QE. The Euro and Yen tanked, and oil prices and commodities collapsed. FX and oil trade easily with ETFs now. Those were crowded inverse, or short trades too.

A new third leg opened in this "Big Short" playbook about the Fourth of July 2015. This leg down centered on oil prices and pessimism about China, both accessible by ETFs.

The only positive way to spin this, at the risk of sounding like I am spinning this, is this all took place in the worst global backdrop for stock sentiment in many years, particularly regarding China. Tone does play a role. Moving across October, we could see a major upturn in sentiment. I see short covering in oil, the euro and to some degree in stocks now.

How did we get here?

It started when the U.S. began QE in 2012. It got fresh impetus with the use of the QE tactics by Japan and Europe.

Here is the most orthodox macro explanation for the negative fundamentals used by the bears. Underlying macro stimulus involved with too much cheap money for too long is the primary cause for two paths of activity: Global mimicry of QE and cheap long-term loans to the global oil and commodity complex.

The most conventional way to understand how QE stimulus went awry is to go back to traditional macro. Y (GDP growth) = C (consumption) + I (investment) + G (gov't spending) + NX (net exports). Economists think rate-driven stimulus directly moves I, or Investment. That is the deep Keynesian meaning behind having the I category separate from C, or consumption. This Investment macro category includes both housing and business fixed investment in equipment and structures. That's a key breakdown.

Clearly, the super low QE-driven rates assisted the recovery we see in the U.S. housing markets. What's the other more submerged idea? Super-low rates also stimulated business fixed investment in equipment and structures. That spells more equipment and structures in sectors that are more capital intensive.

What are those capital-intensive sectors? Industrials, Materials and Energy.

We see deep price deflation in the Energy (-64% EPS estimates for Q3) and Commodities (-13.1% ESP estimates for Q3) complex globally. We also see big job cuts at Caterpillar and HP. The Industrials EPS growth is now -5.8% for the coming Q3 quarter. Overcapacity of equipment and structures is a clear cause of the deep price deflation underpinning these three sector cases.

Zacks Sector/Industry/Company Telescope

October Zacks Ranked Sectors show the analyst community sticking with the usual two EPS winners.

Health Care and Consumer Discretionary lead the way. Utilities stay strong to December, without Fed rate hikes until then or later. Info Tech got upgraded to Attractive. Financials are a firm Market Weight this month. Energy and Materials sunk to Very Unattractive sectors, once again, under the weight of struggling China concerns.

(1) Health Care remains Very Attractive. Its three industry groups look solid.

Zacks #1 Rank Company to Look at: Acadia Healthcare ( ACHC )

Nice entry point here after the sell-off. Acadia Healthcare Company, Inc. provides inpatient behavioral health care services. It provides psychiatric and chemical dependency services, including inpatient psychiatric hospitals, residential treatment centers, outpatient clinics and therapeutic school-based programs. Acadia is headquartered in Franklin, Tennessee.

(2) Consumer Discretionary get upgraded to a Very Attractive Sector again. Leaders are Consumer Electronics and Autos. Apparel and Home Furnishings-Appliances are strong too.

Zacks #1 Rank Company to Look at:Aaron's ( AAN )

Aaron's, Inc. is engaged in the sales and lease ownership and specialty retailing of residential and office furniture, consumer electronics, home appliances and accessories. It is engaged in the lease ownership, lease and retail sale of a variety of products, such as widescreen and LCD televisions, computers, living room and bedroom furniture, and refrigerators. The company offers products of various brands, such as JVC, Mitsubishi, Philips, Panasonic, Sony, Dell, Hewlett-Packard, Simmons, Frigidaire and Sharp. Aaron's, Inc. is based in Atlanta, GA.

(3) Utilities stay at Very Attractive. The leader is Utilities-Water Supply now, with Gas Distribution close. Dividend paying defensives stay in play til December.

Company to Look at: Conn Water Services ( CTWS )

Connecticut Water Service, Inc., is a non-operating holding company whose income comes solely from its subsidiaries. The core business is water service to people throughout towns in Connecticut and Massachusetts.

(4) Info Tech rises to Attractive. Telco Services, Electronics and Computer Software industry look best. The Semis are now up to Market.

(5) Industrials get back to Market Weight. Business Products, Aerospace & Defense and Airlines are the leaders. The poorest Zacks ranked industries are Pollution, Machinery, Machinery Electrical and Metal Fabricating.

(6) Financials upgraded to Market Weight. Real Estate and Finance look good. The Investment Funds are Unattractive. Major Banks are Unattractive.

(7) Consumer Staples fell firmly to Unattractive. Food is best at Market. Food/Drug Retail, Agri-business, Beverages and Misc. sink this sector solidly.

(8) Telcos fall to Very Unattractive. Not sure what the story is.

(9) Materials get to Very Unattractive. Paper is holding up well. Metals-Non Ferrous and Steel are the worst, heavily influenced by the China slowdown.

(10) Energy gets a Very Unattractive rating. There is one very bright spot: Energy-Alternate Sources got to Very Attractive. Oil Misc. (Refiners) is Attractive too. The core O&G industry struggles. Coal is in the dumps.

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ACADIA HEALTHCR (ACHC): Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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