SET Monthly Issue April 2011

| April 19, 2011

April 2011


It’s been quite a ride…

Simply put, the bull market off the March 2009 lows is impressive.  The rally has vaulted the S&P 500 from 666 to a recent high of 1,344.  That means large cap stocks more than doubled in just two years… That’s damn impressive.

However, the stock market’s rise has been far from typical…

We’ve seen some truly historic events.  There are unprecedented amounts of government stimulus and never before seen Fed actions.  (Had anyone heard of quantitative easing before this?)

These two actions taken together produced an environment that rewards taking risk. As a result, stocks, commodities, and the like soared as investors piled into the “risk on” trade

Now we’re entering a critical phase… It’s time for the market to stand on its own.

In June, the Fed’s “QE2” program of Treasury purchases will officially end.  It will signal the end of the “risk on” trade.

The sad truth is nobody knows what will happen when QE2 ends.  But our one reference point doesn’t give me much hope.

When the first round of quantitative easing ended in April of 2010, we had the flash crash.  And then the S&P 500 proceeded to shed 17% over the next two months. Suffice it to say, history isn’t on the market’s side…

We do know there has been a strong correlation between the Fed expanding its balance sheet and stock performance.

In other words, stocks go up when the Fed is pumping money into the financial markets.  But as soon as they quit pumping, stock prices fall… and fall dramatically.

What’s more, earthshaking events from around the globe have put the economic recovery in jeopardy…

Violent political uprising in the Middle East and Africa is disrupting oil prices.  An earthquake, tsunami, and nuclear crisis in Japan are crippling the world’s third largest economy.  The sovereign debt crisis is spreading from Europe to the US.  And China is rapidly raising interest rates to cool inflation.

And to top it off, we’re heading into the summer doldrums.  It’s a time when the stock market is usually weak.  It’s the old saying “sell in May and go away”.

Well, I’m not selling… But I am shifting gears.

I think we’re entering a period where “safe” or defensive stocks will outperform riskier cyclical stocks.  In fact, we’ve already begun to see investors shift toward these unloved sectors.

This month I’ve got two rock-solid ETFs designed to carry us through the end of market manipulations and the summer doldrums.


Investing in healthcare stocks has been tricky business lately…

The industry has battled uncertainty from healthcare reform for years.  As a result, many investors have avoided investing in healthcare altogether.

But the bottom line is healthcare is big business.  The US spent $2.5 trillion, or $8,047 per person, on health care in 2009 alone.  That’s 17.3% of US GDP…

And now the Fed is preparing to end their market manipulation.  It’s the perfect opportunity for this unloved and undervalued sector to shine.

Macro/Economic Trend:   Healthcare Reform Fears Are Overblown

Healthcare providers made a big deal about the the Patient Protection and Affordable Care Act (PPACA) becoming law last March.

They said the industry would be crippled by the high cost of reforms.  But so far those fears have been unfounded.  In fact, many healthcare companies are guiding for higher earnings than analysts were expecting.

Simply stated, the impact of healthcare reform on the sector’s profitability has been overstated.

What’s more, I view healthcare reform as a big positive…

It’s estimated that 32 million previously uninsured individuals will have health insurance by 2019.  That many new people entering the system should drive revenue and earnings growth.

The bottom line is the costs of complying with the new healthcare reforms should be offset by higher premiums.  And in the long run, having more people covered by health insurance will be a positive for the industry.

The result?

It’s time to invest in the healthcare providers.  The iShares Dow Jones US Healthcare Providers (IHF) is designed to give us exposure to the biggest and best companies in the industry.

Fundamentals:  A closer look at IHF

IHF holds 51 US healthcare stocks.  The ETF tracks the Dow Jones US Select Health Care Providers Index.

The expense ratio is 0.47%.

The top five holdings and percentage weights for IHF are –

Company Name Ticker % Weight
Unitedhealth Group UNH 14.08%
WellPoint WLP 8.71%
Express Scripts ESRX 8.70%
MedcoHealth Solutions MHS 7.59%
Aetna AET 5.23%

Technicals:  The charts lead the way

IHF is in a strong uptrend… It’s set a series of higher highs and higher lows over the last seven months.  And more recently it’s shown impressive relative strength.

In other words, IHF goes up more than the market when the market’s rising.  And when the market pulls back, IHF goes down less than the market.

Take a look at this chart of IHF…


You can see when IHF was going down in March, the 50-day moving average stopped the ETF’s retreat.  Clearly, this moving average is providing strong support for the uptrend.

And now, IHF is pulling back toward this support line… It looks like a great buying opportunity to me!

Trade Alert

Buy:  iShares Dow Jones US Healthcare Providers (IHF) up to $62.00
Recent Price:  $60.62
Price Target:  $75.00
Stop Loss:  $56.00

Remember:  IHF is coming into support at the 50-day moving average, currently $60.29.  This should represent a good buying opportunity. I ’m expecting IHF to bounce off of this support zone and move higher.


Consumer staples are a slow-growing mature market.  But it’s a massive market.  The household products industry alone generates more than $72 billion in revenue every year!

In other words, the sector’s a cash cow.

Consumer staples benefit from constant demand.  People always need food, toilet paper, and tooth paste.

And to top it off, it’s chock-full of undervalued dividend payers.  It’s just the type of investment with the potential to shine through the summer doldrums.

Macro/Economic Trend:  Sector Rotation

According to the sector rotation theory, we are approaching the end of the business cycle’s expansionary phase.

You see, the end of the expansionary phase is typically marked by the energy sector’s outperformance.  And that’s exactly what’s happened over the last six months…

It’s a crystal clear sign that our economic expansion is due for a slow down.

Simply put, rising energy prices drive up inflationary pressures.  The rising costs lead to slowing economic growth.  And if left unchecked, they lead to a period of economic contraction.

Don’t get me wrong… I’m not turning bearish.  I don’t think we’re destined for economic contraction or a recession.

However, I do believe investors are leaving overvalued cyclical stocks in a mass exodus.  And for good reason… Remember, there’s a laundry list of potential pitfalls for stocks and the economy.

Food and energy costs are skyrocketing… Inflation… The Fed is ending QE2… We’re entering the summer doldrums… Politicians can’t agree on a budget… The national debt is skyrocketing… The earthquake in Japan disrupted global supply chains… Political turmoil in the Middle East and Africa… Housing is still a major drag on the economy… And job creation is anemic at best…

The bottom line is I think the conditions are ripe for big money investors to rotate into defensive sectors.

One ETF set to profit from this sector rotation is the Consumer Staples Select Sector SPDR Fund (XLP).

Fundamentals:  A closer look at XLP

XLP holds 41 S&P 500 companies who are engaged in food & staples retailing, household products, food products, beverages, tobacco, and personal products.

The expense ratio is 0.2%. And the dividend yield is 2.92%.

The top five holdings and percentage weights for XLP are –

Company Name Ticker % Weight
Procter & Gamble PG 14.53%
Philip Morris Intl PM 9.67%
Wal-Mart WMT 8.48%
Coca-Cola KO 7.39%
Kraft Foods KFT 4.72%

Technicals:  The charts lead the way

XLP recently broke out to a new all-time high.  It’s set the stage for XLP to surge to new heights.

Take a look at the XLP’s chart over the last few months…


You can see XLP ran into stiff resistance at $29.75.  This was the previous all-time high set back in December 2007.

But once XLP cleared this hurdle a few weeks ago… it was off to the races!

XLP’s recent breakout is extremely bullish.  And since it’s a new all-time high, there’s minimal overhead resistance.  I see clear sailing ahead for XLP.

Trade Alert

Buy:  Consumer Staples Select Sector SPDR Fund (XLP) up to $31.50
Recent Price:  $30.67
Price Target:  $38.00
Stop Loss:  $29.00

Remember:  XLP recently broke out to new all-time highs.  The breakout is being driven by investors rotating out of cyclical stocks and into defensive stocks ahead of the summer slowdown.  I think XLP will continue to outperform cyclical stocks in the weeks and months ahead.


Consumer Discretionary (+0.6%)

Retail sales were up for the ninth straight month in March.  That’s good news for consumer discretionary stocks.  So far, higher prices at the gas pump haven’t forced cut backs in other areas of spending.

And to top it off, consumer sentiment, a leading indicator of consumer spending, came in better than expected this month.

Clearly American consumers are resilient.  But job growth and housing need to make some big strides toward normalcy if the sector has any hope of continuing to grow.

Consumer Staples (+3.7%)

Consumer staples are taking the lead.

In fact, they posted the largest gain of any sector over the last month.


Investors are rotating into defensive sectors as risk heats up.  I’m recommending theConsumer Staples Select Sector SPDR Fund (XLP) to profit from this massive shift in investor behavior.  See Trade Alert 2 for more details…

Energy (+2.8%)

Energy stocks are becoming more volatile.

As usual, the sector’s fortunes are tied to the price of oil.  And right now I’m very suspicious of oil…

The bottom line is oil prices are being driven by speculation and fear.  The market is completely disregarding market fundamentals.

Here’s how crazy the oil market is right now…

Oil prices are at their highest level since 2008.  Yet, Saudi Arabia is cutting production because there’s a glut of oil on the market.  There’s simply no way to justify oil’s current price.  I think we’re going to see a massive 20% to 30% correction in oil and the related energy stocks.

Financials (-2.4%)

Financial stocks took another step back this month.

Investors weren’t impressed with the quarterly earnings reports from JP Morgan Chase (JPM) and Bank of America (BAC).  The banks are profitable and credit conditions are improving.

But they’re lacking one key element.  They haven’t shown how they’ll grow earnings in the new regulatory environment.  This is clearly a disappointing development.

As a result, our SPDR KBW Bank ETF (KBE) has given back part of our gains.  The good news is we’re still up more than 10% from our buy price.  Let’s lock in our 10% gain. Go ahead and sell KBE now…

Our iShares FTSE NAREIT Residential Plus Capped Index Fund (REZ) is looking strong.  Demand for apartments continues to outpace new supply.  That’s a good sign residential REITs profitability will increase.  Continue holding REZ for bigger gains ahead.

Healthcare (+3.7%)

Healthcare stocks are surging.

Investors are rotating into defensive sectors.  It’s a major shift in investor behavior. I’m recommending the iShares Dow Jones US Healthcare Providers (IHF) to profit from the sector rotation into healthcare sector.  See Trade Alert 1 for more details…

Industrials (+1.3%)

Industrials bounced back to post a modest 1.3% gain after suffering their first setback in seven months last month.

The good news is industrials are one of the strongest sectors of the economy.  They’re solid fundamentally and they have a ton of cash on their balance sheets.

Not to mention, global demand for industrial and farm equipment isn’t going away anytime soon.

I’m expecting industrial stocks to hold up well under any market conditions.  And in the end, I think they’ll lead the market’s next leg higher.  Continue holding the iShares Dow Jones US Industrial Sector Index Fund (IYJ) and the Market Vectors Agribusiness ETF (MOO).

Technology (-0.2%)

Tech stocks have lost their ‘mojo’.

The sector has entered into a downtrend off the February highs.  The weakness is being led by semiconductor stocks.  It will be interesting to see how earnings from the big name tech companies like Apple (AAPL) and Intel (INTC) impact investor optimism.

The good news is our iShares S&P North American Technology-Software Index Fund (IGV) and the PowerShares S&P SmallCap Technology Portfolio (PSCT) are holding up better than other tech ETFs.

I think tech still has a bright future.  Continue holding IGV and buy PSCT up to $33 if you haven’t already.

Materials (+2.8%)

Materials stocks are bouncing back thanks in large part to gold mining stocks.  That’s great news for our Market Vectors Gold Miners ETF (GDX).  GDX hit a peak gain of 13.5% as gold prices soared to record highs of $1,500 an ounce.  The big move sent GDX past our buy up to price, so I’m moving it to a hold.

Best of all, gold should continue its impressive run.  The turmoil in the currency markets is causing investors to hedge their currency holdings by owning commodities and precious metals.  I see gold and the gold mining stocks moving higher in the days and weeks ahead.

Utilities (-1.3%)

Utilities continue to trade in tight range.

The defensive sector is struggling to gain a foothold with investors.  We’ll keep utility stocks on the back burner for now.

Portfolio Changes

  • This month we’re buying IHF and XLP.
  • Move Market Vectors Gold Miners ETF (GDX) to hold.
  • Sell SPDR S&P KBW Bank ETF (KBE) for gains of 10% or more.


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