SET Monthly Issue April 2010

| April 20, 2010

April 2010


I love it when I see terms like “melt up” being tossed around by the media.  It just oozes contempt for the current bull market rally.

It tells me there are still plenty of people who think they’re smarter than everybody else (and the market).  They think the bull market is doomed to fail.

And it will, someday… But it’s not going to happen anytime soon.  At least if history has anything to say about it.

Over the last 15 bull markets, the median length is 2.6 years and the average is 3.4 years.

So don’t be surprised to see optimism carry the current bull market on for at least another year.

To be sure, there are going to be setbacks along the way.

Sovereign debt issues, like we’ve seen in Greece, unemployment, and unexpected market shocks (like the SEC lawsuit against Goldman Sachs (GS)) will trigger short term selloffs.

But time and time again we’re seeing buyers step in when the markets do pullback.

It’s a pattern of behavior that’s dominating stock market movements.  As I love to say, the trend is our friend.  And that trend is for the markets to continue moving higher.

***Editor’s Note***

Before we get to this month’s trade, I wanted to give you a special “heads-up” on a new service we’re launching in May.  I’m very excited about this and feel it’s a perfect complement to what we’re doing here with Sector ETF Trader.

In fact, I’ve been using this new tactic in my own trading account and have been absolutely blown away by the results…

This new service will be much more aggressive, and will have a much shorter hold time on the positions.  It’ll also take advantage of double and triple leveraged ETFs to really pump up the profits (you’re not going to believe the returns we’re seeing right now!)

And, as a special ‘thank you’, we’ll be offering this new service at a substantial discountto Sector ETF Trader members like you… and we might even give you ‘first dibs’ at securing your membership before other customers!

Anyway, keep an eye on your email inbox for further details on this amazing strategy later in the week.

Ok, on to this month’s trade…


The American consumer is on the mend.  And I’ve got to admit, the “new normal” is even better for the economy than the old one.

You see, many experts thought it would take years for households to de-leverage their balance sheet.  They expected a “new normal” of slow spending and deleveraging by paying down debt.

It was expected to be a drag on the economy for years.  But they underestimated Americans will to continue living the lifestyle they’re accustomed to.

Instead of a slow and drawn out de-leveraging, we’re seeing people take drastic measures.  And it’s fueling a massive rebound in consumer spending.

Macro/Economic Trend: De-Leveraged Consumer

In 2009, 1.4 million people filed a consumer bankruptcy and 2.8 million homes were foreclosed.

Another 1.5 million people are expected to file bankruptcy this year and as many as 4 million more foreclosures are expected in 2010.

These numbers are shocking.  Or maybe not, considering the credit and housing bubble that built up over the last decade.

But once you get past the initial shock and moral argument, you’ll see the high rates of bankruptcy and foreclosure are a good thing.

It’s good because consumers have money to continue funding our consumer driven economy.

Think about it…

The US economy has lost over 8 million jobs in the last few years.  The people who lost their job are able to qualify for a chapter 7 bankruptcy.  This type of bankruptcy wipes the slate clean or significantly reduces the amount of debt they owe.

So after bankruptcy, a consumer can take a lower paying job and still have more disposable income.

And foreclosures are giving consumers even more money to spend.  Here’s why…

The first and most immediate is the “free ride”.

The entire foreclosure process from the first missed payment to eviction can take more than a year.  The length of this process essentially eliminates the housing expense for consumers for an extended period of time.

Once they are finally evicted, they have a couple of choices.

They can rent.  Renting a house usually costs about half of their old mortgage payment.  Or if they have the money or a spouse with good credit, they can buy another now cheaper house.  That means a much lower mortgage payment.

Consumers are using this ‘found’ money to fuel the economy.  This is why consumer spending will continue to rebound faster than economists think.

It’s true, the free ride won’t last forever.  But it’s giving consumers hardest hit by the recession a chance to pay down debt.  They’re also able to keep the same level of (or even increase) spending.

It’s a “stealth stimulus program” the government is supporting.

The boost the economy gets from consumers defaulting on debt is one reason why the government has put moratoriums on foreclosures.  And why the Fed has a ZIRP (zero interest rate policy).

A temporary moratorium on foreclosures stretches out the “free ride” period.

And a ZIRP allows banks to borrow money at 0% from the Fed.  Then banks invest the money in risk free T-Bills and government backed mortgages.  They’re capturing a huge interest rate spread.

Just look at the recent quarterly earnings reports from the large banks like JP Morgan(JPM) and Bank of America (BAC).  They all say “stronger trading revenue helped offset loan losses”.

ZIRP is a cash producing machine for banks.  And it’s allowing them to absorb the losses from bad loans and still turn a nice profit.

And we haven’t even looked at the job market.  When the job market improves, we’ll see consumer spending accelerate even faster.

Right or wrong, this is the reality.  I’m not here to pass judgment on anybody.  I’m just capitalizing on a profitable trend that’s not fully priced into consumer discretionary stocks yet.

The ETF I like to play this trend is the PowerShares S&P SmallCap Consumer Discretionary Portfolio (XLYS).

Fundamentals:  A closer look at XLYS

XLYS holds 113 small cap consumer discretionary stocks.  The index is a market cap weighting of the consumer discretionary stocks in the S&P 600.

The expense ratio is 0.29%.

The top five holdings and percentage weight for XLYS are –

Company Name Ticker % Weight
Tractor Supply Co. TSCO 3.13%
Live Nation Entertainment LYV 2.83%
Carter’s Inc. CRI 2.46%
Polaris Industries Inc. PII 2.39%
Deckers Outdoor Corp. DECK 2.27%

Technicals:  The charts lead the way

XLYS is a new ETF.  It began trading earlier this month on April 7, 2010.  Its short existence doesn’t allow for meaningful technical analysis on the ETF itself.

Below you’ll see a chart of the S&P 600 SmallCap Consumer Discretionary Index for the last year.  (The index the ETF is based on.)

You can see the index is in a strong uptrend.  This is similar to what we’re seeing in the large cap consumer discretionary sector.

S&P 600 Small Cap Consumer Discretionary Index
Chart from

But the small cap stocks are blowing the large cap stocks away.  Since February 8th, the small cap index has tacked on 32%.  Over the same time, large cap stocks are (only?) up 20%.

Clearly, the small cap stocks are showing relative strength to the large cap stocks.

Trade Alert

Buy:  PowerShares S&P SmallCap Consumer Discretionary Portfolio (XLYS) up to $27.75
Recent Price:  $26.47
Price Target:  $34.50
Stop Loss:  $23.75

Remember:  The market’s had a great run over the last few months.  But it’s not going to go straight up forever.  If the markets do have a short term pullback, the riskier and more volatile small cap stocks will take a bigger hit than large cap stocks. But the upside is also much bigger.  We’ll give this one plenty of wiggle room so we’re not stopped out by a short term pullback.  But over the next few months, XLYS should pay off big as consumer spending outpaces economists’ estimates.


Consumer Discretionary (+6.7%)

Retail sales came in better than expected again this month.  It’s a trend I think will continue to push consumer discretionary stocks even higher.  We’re recommendingPowerShares S&P SmallCap Consumer Discretionary Portfolio (XLYS) this month… see above for more details.

Our SPDR S&P Homebuilders ETF (XHB) hit a peak gain of 18.9% this month.  The March report on housing starts was extremely positive.  It came in better than expected.  And the February data was revised higher.  That means the number of new housing starts have now risen for three straight months.  A good sign XHB should continue to move higher from here.

Consumer Staples (+1.6%)

The SuperCenter, Tobacco, and Soft Drink industries in the consumer staples sector are the few bright spots for this defensive sector.  Overall, staples continue to lag more cyclical sectors.  The sector should continue improving as consumer spending increases.  But for now, there are bigger gains to be had elsewhere.

Energy (+1.4%)

The price for a barrel of crude oil broke out to a new recovery high of around $87.  But the rally in oil prices isn’t doing the same for energy stocks.  Just look at the Select Sector SPDR Energy Fund (XLE).  XLE hasn’t been able to crack the highs it set in October ’09 or January of this year.  Clearly there’s some sort of disconnect. The obvious answer seems to be natural gas prices.  They have fallen from $6 to $4. The crosswinds have left the energy sector flapping in the wind.

Financials (+5.3%)

Financials are enjoying another solid month of gains.  The large money center banks continue to offset loan losses with increased trading revenue.  It looks like the backdoor bailout via the Fed’s ZIRP (zero interest rate policy) will allow them to “earn” their way out of the credit crisis.  I guess even banks can’t screw up a system where they can borrow at 0% and earn risk free returns of 3% to 6%.

In typical government fashion, the banks are being given a handout with one hand and being brow beaten by the other.  The arm doing the brow beating this week is the SEC.  The SEC filed a lawsuit against Goldman Sachs (GS) for defrauding investors in mortgage-backed securities.  I’m staying away from financials until this whole mess is sorted out.

Healthcare (-0.7%)

A healthcare reform bill has finally been signed into law.  As Vice-President Biden remarked, “This is a big f*@!ing deal.”

So far, healthcare stocks haven’t responded to the passage of the bill.  Investors are unsure of how the new law will impact profitability.  Clearly having more insured people in the system will boost sales in the drug and medical device industries.  But will those sales translate to more earnings?  It’s still uncertain.  Until healthcare stocks gain some momentum, I’m steering clear.

Industrials (+5.7%)

Our Vanguard Industrials ETF (VIS) hit our price target earlier this month.Congratulations to everyone locking in a 32.5% gain!

Our transportation ETF, iShares Dow Jones Transportation Index Fund (IYT), continues to set new highs as well.  It hit a peak gain of 15% last week.  The gains are being fueled by United Parcel Service (UPS) pre-announcing a 37% YOY increase in first quarter earnings.  The earnings handily beat analyst estimates.

The bottom line is industrials are growing revenue and earnings.  As long as the economy continues to improve, the industry should move higher as well.

Technology (+4.3%)

IT spending on both the personal and business level is accelerating.  Both of our technology ETFs are showing solid gains.  The Rydex S&P Equal Weight Technology ETF (RYT) is up more than 7% in the first month.  And the SPDR S&P Semiconductor ETF (XSD) is up 16.6%.

Last week, tech bellwether Intel (INTC) reported another spectacular quarter. Management also boosted their guidance Q2 sales above analyst estimates.  The global demand for technology is strong enough to prompt Intel’s CEO to say “the semiconductor industry is now fully recovered”.  I couldn’t have said it better myself.

Materials (+3.1%)

Basic materials’ stocks continue to trend higher.  They’re being led by small and mid- cap stocks.  We’ve got all of our bases covered by three ETFs in this sector.

The Market Vectors Junior Gold Miners (GDXJ) is nearing our buy up to price.  I think it’s only a matter of time before gold surges higher again.  And when it does, GDXJ should outpace the rise in the metal itself.

We also got back into Market Vectors Agribusiness Fund (MOO) last month.  MOO has pulled back to the support line of the uptrend.  We should see it move higher from here.

Our best performing ETF in the sector is the Rydex S&P Equal Weight Materials ETF(RTM).  It hit a peak gain of 17% last week.  RTM is showing relative strength to the market cap weighted Materials Select Sector SPDR (XLB).  It should continue to rack up more gains on the way to our price target.

Utilities (+0.0%)

Utility stocks have settled into a range.  There doesn’t seem to be much interest from buyers or sellers.

I still like utilities because of their dividend yield.  But right now investors are chasing risk and higher returns in other sectors.

I am seeing some of the small cap utility stocks starting to move higher.  I wouldn’t be surprised to see momentum in the small caps spill over into our large cap Utilities Select Sector SPDR Fund (XLU).

Portfolio Changes

  • This month we’re buying XLYS…
  • Vanguard Industrials ETF (VIS) hit our price target.  Sell for a 32% gain!
  • Move Rydex Equal Weight Technology ETF (RYT) to hold.
  • Move SPDR S&P Semiconductor ETF (XSD) to hold.

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