SET Monthly Issue August 2011

| August 16, 2011

August 2011


Let’s face it.

I jumped the gun with my bullish call on the markets last month.  Obviously, an 18% correction in the S&P 500 is anything but bullish.

Yet, that’s exactly what happened from July 21st to August 9th.  The S&P 500 shed 247 points as panicked investors hit the sell button.

And here’s the kicker… I was expecting a massive selloff like the one we got!

In the February issue I said, “I’m starting to get a little uneasy…

We’re really in unchartered territory.  We’ve never seen the Fed expand its balance sheet to this size before.  So there’s no telling how or when this bull market will end.”

Then in March I told you “in the short-term I think the bad news has reached a tipping point.  It’s time for a market correction.”

And again in April, “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…”

In May, “It’s a clear sign of a market running out of gas.  And it’s a trend I expect to continue throughout the summer.”

And then I really hit the nail on the head in June.

“Economists will have no choice but to slash their predictions for US and Global economic growth.

And it’s just the beginning… I believe the economy’s going to get worse before it gets better.

What’s more, I think economists will slash their growth predictions too far in the second half.  As usual, they’ll extrapolate on the weak economic data and begin calling for a recession.

When they do, it will offer up some great buying opportunities. Until then, it’s best to play defense.”

And even last month I said, “Prepare yourself for a bumpy ride… because stocks are stuck in the 24 hour news cycle.”

Now, after the correction I had been waiting for, it’s time to get bullish!

Simply put, everything is playing out how I expected.

However, I didn’t think the correction would be this strong or impact defensive stocks so negatively.  But then again, I never thought the US would lose its AAA credit rating either. And I was wrong on both counts…

At this point, it’s water under the bridge.  It’s time to get to the heart of my argument… weaker than expected economic data and negative headlines fueled an investor panic.  And more importantly, it’s created a fantastic buying opportunity!

The bottom line is, right now everyone assumes the slowdown will continue unabated until the economy dips into a recession.  But the truth is, there’s no evidence things will actually get that bad.

Remember, companies have shown a fantastic ability to grow revenue and earnings even as economic growth slows.  As a result, even with modest 1.5% US GDP growth, stocks are a screaming buy.

When investors realize the economy isn’t as bad as they thought, they’re going to flood back into stocks.  Let’s grab two ETFs that should outperform as stocks come roaring back.


Last month was brutal for stocks…

Investors feared the worst as economic growth slowed, European sovereign debt issues reemerged, and a nasty debate over the US debt ceiling raged in DC.

Fear quickly spilled over into panic.  Investors sold stocks across the board.  And oil prices collapsed from $100 to less than $80 per barrel.

Clearly, investors were bracing for another recession.  But so far, there’s no evidence the global economy is destined to sink back into one.

Macro/Economic Trend:  Low Expectations

The International Energy Agency (IEA) jumped aboard the panic bandwagon last week.

In their monthly oil market report, the IEA said, “In the wake of recent market turmoil and souring economic indicators, the potential has grown for lower-than-assumed economic growth and oil demand.”

Now the IEA expects global oil consumption to increase by 1.6 million barrels a day, or 1.8%, in 2012.  But if the economy slows, demand could grow by less than half of their current estimates.

The shocking forecast sent oil prices tumbling into the mid-$70s per barrel.  It was the cheapest price for a barrel of oil since last September.

I think investors overreacted…

Even in the IEA’s worst case scenario, oil demand is still projected to grow.  And there’s no evidence supply will be able to keep pace with the increased demand.

Right now the Saudis are pumping more oil than they have in 30 years.  And OPEC has little spare output capacity to increase production.

Yet, total oil inventories in advanced economies declined by 11.8 million barrels in June.  And this is the time of year stockpiles are typically increasing!

Here’s the bottom line…

Even though the IEA is projecting slowing demand, there’s no evidence to support their claims.  In fact, based on recent inventory data, demand for oil is still rising even though economic growth is slowing.

If demand for oil continues to outpace the low estimates, oil prices should quickly rebound into the mid-$90s.  And that will send oil and gas stocks screaming higher. One ETF I like to profit from soaring oil prices is the PowerShares S&P SmallCap Energy Portfolio (PSCE)

Fundamentals:  A closer look at PSCE

PSCE holds 21 small cap energy stocks.  The ETF tracks the energy stocks in the S&P SmallCap 600 Index.

The expense ratio is 0.29%.

The top five holdings and percentage weights for PSCE are –

Company Name Ticker % Weight
World Fuel Services INT 12.01%
Lufkin Industries LUFK 10.44%
SEACOR Holdings CKH 9.64%
Gulfport Energy GPOR 6.00%
Pioneer Drilling PDC 4.92%

Technicals:  The charts lead the way

PSCE went through a major correction last month.  It fell nearly 33% from July 22nd to August 9th!  That’s an amazing swing in just a few weeks…

The massive selloff pushed PSCE deep into oversold territory.  When a stock or ETF becomes oversold, we’ll often see it rebound quickly.

As expected, PSCE has moved quickly higher as it bounced back from oversold conditions.  But with the ETF still in oversold territory, there’s still plenty of room for it to run higher.


What’s more, the charts of PSCE’s top five holdings (listed above) look great too!  And they’re the stocks making the biggest impact on PSCE.

The result?

It’s time to grab PSCE.  These shares are poised to make bigger gains as PSCE rebound from oversold conditions.

Trade Alert

Buy:  PowerShares S&P SmallCap Energy Portfolio (PSCE) up to $36.00
Recent Price:  $34.92
Price Target:  $43.00
Stop Loss:  $28.50

Remember:  PSCE is quickly rebounding from oversold conditions.  And it should continue soaring as oil prices jump back into the mid-$90s per barrel.  Go ahead and grab your shares now before PSCE clears our $36 buy up to price.


With this next recommendation, I’m reiterating my support for the consumer.  We’re going right back into the retail sector ETF.  Unfortunately, I jumped the gun by recommending this ETF last month.

But don’t be fooled… just because our trade didn’t work out doesn’t mean we were wrong.  In this case, we were just a month too early.

Now, the case for investing in retail stocks is even stronger than before.

Macro/Economic Trend:   Market Extremes

In short, the reason to buy retail stocks hasn’t changed from last month.

As you know, the debt ceiling debate and the ensuing panic-fueled stock market selloff has taken a toll on consumers.  Many are scared out of their minds.

In fact, consumer confidence has fallen off a cliff.  Just take a look at this chart of the University of Michigan Consumer Sentiment Index.

UM_Consumer_Sentiment 081611

As you can see, consumer sentiment fell from 71.5 in June to 63.8 in July and then down to 54.9 in August.  It’s now at the lowest level since April 1980!

Scary, I know…

But the capitulation in consumer confidence is actually good for stocks.

You see, extremes in consumer sentiment are often a good contrarian indicator.  In other words, extremely low consumer confidence readings often occur at the same time as a market bottom.

Don’t believe me?

Look at the chart again.  You’ll see the last time we had extremely low consumer confidence was at the market bottom of March 2009.

It was the time of great worry about the credit crisis.  But we all know what happened next.  The market went on a two year bull market run – And the S&P 500 soared by 105%!

What’s more, consumers are continuing to spend money at retailers.

Just look at the recent retail sales figures that came out on Friday.  They show July retail sales were better than expected.  Sales grew by 0.5% after increasing 0.1% in June.

No doubt about it, consumer spending is healthy despite extremely low consumer confidence.

I think this is a clear cut market bottom.  And retail stocks are going to lead the market’s next move higher.  Let’s buy the SPDR S&P Retail ETF (XRT) now to profit from the coming surge in consumer spending.

Fundamentals:  A closer look at XRT

XRT holds 95 retail stocks.  The ETF tracks the S&P Retail Select Industry Index.  It’s an equal weight index.  That means all 95 stocks have an equal impact on the ETF.

The expense ratio is 0.35%.

The top five holdings and percentage weights for XRT are –

Company Name Ticker % Weight
PriceSmart PSMT 1.45%
Monro Muffler Brake MNRO 1.33%
Asbury Automotive Group ABG 1.30%
Stage Stores SSI 1.28%
Wet Seal WTSLA 1.27%

Technicals:  The charts lead the way

Last month, XRT’s chart looked good.  It was in a solid upward trending price channel. Then panic hit… Stocks were cutting through support zones like a hot knife through butter.

Now, XRT looks even better… Take a look at a chart of XRT going back to 2007.


As you can see, XRT is still in a long term uptrend off the November 2008 bottom.

But more importantly, it’s trading at a major support zone around $45.  XRT reached a high of $45 in June 2007 and again in April 2010.  At the time, $45 was an area of strong resistance.  Once XRT broke through resistance, it became a support zone.

Now XRT is testing this support zone.  Not surprisingly, we’ve seen volume increase as buyers step in to pick up shares at this level.

Simply put, XRT’s chart is screaming “Buy, Buy, Buy!”

Trade Alert

Buy:  SPDR S&P Retail ETF (XRT) up to $49
Recent Price:  $47.77
Price Target:  $65.00
Stop Loss:  $42.50

Remember:  XRT is in a long term uptrend and just above a major support zone around $45.  Grab your shares now before XRT rebounds from these extremely oversold conditions.

Consumer Discretionary (-10.5%)

Retail sales surprised to the upside in July.  It’s the second month in a row they came in better than expected.  They grew a solid 0.5%.  That’s a clear indication the economic slowdown hasn’t crushed the consumer yet.

Unfortunately, the solid fundamentals were trumped by the market selloff.  At one point, the sector was down a staggering 14% from the recent high.  As a result, theSPDR S&P Retail Fund (XRT) we recommended last month hit our $49 stop loss.

However, I think retail stocks still have a bright future.  So we’re recommending SPDR S&P Retail Fund (XRT) again this month… see Trade Alert 2 for more details.

Consumer Staples (-5.8%)

Consumer staple stocks held up better than cyclical stocks in the correction.  But they were still dealt some heavy losses.

Our Consumer Staples Select Sector SPDR Fund (XLP) closed below our $29 stop loss on August 8th.  That’s our cue to sell.  Everyone should be out of XLP with a small loss.

Energy (-12.9%)

Energy stocks plummeted this month.  The good news is they’re already bouncing back. In fact, I think small cap oil and gas stocks could rack up some of the biggest gains in the coming weeks.  I’m recommending the PowerShares S&P SmallCap Energy Portfolio (PSCE)… see Trade Alert 1 for more details.

Financials (-13.9%)

Financial stocks took another beating this month.  The sector is clearly oversold.  But I’m not interested in owning financial stocks at any price right now.  The sector is facing too many headwinds for my taste.

In short, there are better opportunities than financial stocks right now.

Our iShares FTSE NAREIT Residential Plus Capped Index Fund (REZ) gave us a scare this month.  The price collapsed from more than $45 to $36.50 per share.  That’s a 19% swing in just a few weeks!  It was a perfect example of panic selling… Now REZ is on the upswing once again.  Continue holding REZ…

Healthcare (-10.1%)

Healthcare stocks were hit with a triple whammy this month.

First off, Medicare and Medicaid cut their reimbursement rates to skilled nursing homes by 11.1%.  It’s estimated to cost the industry $79 billion in funding.

Then as part of the debt ceiling negotiations, federal funding for Medicaid and Medicare was put on the chopping block.  Not a good sign for healthcare companies…

And last but not least, the panic fueled market selloff hammered speculative stocks like biotech.

As a result, SPDR S&P Biotech ETF (XBI), S&P SmallCap Healthcare Portfolio(PSCH), and iShares Dow Jones US Healthcare Providers (IHF) all hit their stop losses on August 4th.  That’s our cue to cut our losses and look for better opportunities.

Industrials (-14.1%)

Industrial stocks took a beating this month.  It shouldn’t have come as a surprise.  The economic slowdown started as a slowdown in manufacturing.  And so far, the leading indicators don’t show a revival in manufacturing activity.

Our Market Vectors Agribusiness ETF (MOO) survived the market chaos of the last few weeks.  The good news is grain prices are holding up remarkably well.  That bodes well for farm income.  And the more money farmers make, the more they’ll spend with Agribusiness companies.  Continue holding MOO for bigger gains ahead.

Technology (-6.9%)

Technology stocks have held up surprisingly well over the last few weeks.

But the reality is tech stocks have been stuck in neutral for most of the year. One reason for the weakness is tepid analyst growth estimates this quarter.

However, the low bar could set the stage for tech stocks to deliver better than expecting earnings. If they do, look for tech stocks to rally.

Materials (-13.0%)

Overall, materials stocks got hammered last month.  A 13% drop is just plain ugly…

One area of strength in the materials sector was gold miners.  Our Market Vectors Gold Miners ETF (GDX) is hanging onto a small gain.  However, the miners continue to lag behind the physical metal.  I believe we’ll see gold mining stocks play catch up once the stock market stabilizes.  Continue holding GDX for bigger gains.

However, our Market Vectors Rare Earth/Strategic Metals ETF (REMX) didn’t fare as well.  At the height of the panic, REMX closed below our $20 stop loss.

Unfortunately, that’s our cue to sell.  Go ahead and sell REMX to conserve capital if you haven’t already.

Utilities (-5.0%)

Utilities are looking good for a run higher in the second half of the year.  That’s good news for our Utilities Select Sector SPDR Fund (XLU).  Remember, the third quarter typically has the most cooling days.  That will add to power consumption.  And the more power customers use, the more money utilities make.  With XLU still trading below our buy up to price, go ahead and buy it up to $34 if you haven’t already.

Portfolio Changes

  • This month we’re buying PSCE and XRT
  • Sell Consumer Staples Select Sector SPDR Fund (XLP)
  • Sell SPDR S&P Biotech ETF (XBI)
  • Sell S&P SmallCap Healthcare Portfolio (PSCH)
  • Sell iShares Dow Jones US Healthcare Providers (IHF)
  • Sell Market Vectors Rare Earth/Strategic Metals ETF (REMX)


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