SET Monthly Issue August 2012

| August 21, 2012

August 2012


It’s been an exciting few months on Wall Street…

Stocks are in the midst of an epic rally.  The S&P 500 has shot from 1,266 on June 4th to 1,418 this week.

The rally has erased all of the losses the large cap index racked up in April and May. And it’s right back at the bull market high.

Obviously, it’s great news for our ETFs!

Let’s take a closer look at what’s behind the market’s impressive performance…

First off, the most important catalyst for this rally is stability in Europe’s debt markets. At long last, Europe’s Central Bank has finally found a solution the market likes.

In a nutshell, the EU has a bailout fund.  They will use the fund to buy sovereign debt of the member countries to prevent yields from rising above 7%.

This essentially puts a ceiling on European sovereign debt yields.  The plan all but eliminates the potential for rising interest rates to trigger massive defaults many feared would lead to another credit crisis.

And just like that, investors were finally able to put the worst of Europe’s troubles in the rearview mirror.

Here’s the thing…

At this point, investors are starting to rotate money.  They’re moving money out of safe haven investments and into cyclical sectors.

Over the last month, US Treasuries, utilities, consumer staples, and healthcare have begun to lag behind.  At the same time, technology and energy stocks are leading the markets higher.  And the bullish sentiment is spilling over into other cyclical sectors as well.

This month we’re recommending two sector ETFs that should reap the rewards of more money flooding into cyclical sectors.


What’s the one thing that’s guaranteed to drive a stock price higher?

If you said sales growth, growing earnings, a solid dividend, or margin expansion… you’d be dead wrong.  You see, when it comes right down to it, a stock only goes up for one reason.

Put simply, the reason a stock goes up is because there are more buyers than sellers. And as long as there are more buyers than there are sellers, a stock or an ETF tracking a basket of stocks will go up in price.

Here’s the thing…

Right now we’re in the early stages of a powerful sector rotation.  Money is flowing into cyclical stocks.  And that means there are a lot more buyers of cyclical stocks than there are sellers.

One sector benefiting from this buying frenzy is basic materials.

Macro/Economic Trend:  Back In The Saddle

Basic materials stocks are some of the most cyclical stocks in the world.  And for good reason… their revenue growth, earnings, and margins can take wild swings throughout the business cycle.

And unless you’re fond of watching your account balance yo-yo up and down, they’re not stocks you want to buy and hold.  They’re just too volatile.

But here’s the thing…

You want to own basic materials when economic growth expectations are at their lowest.  They are one of the first sectors to soar as economic growth accelerates. And I think we’ve reached the bottom.

According to the US Weekly Leading Index from Economic Cycle Research Institute, economic growth reached a turning point in June.  Economic growth is no longer slowing. It’s on the upswing!

Put simply, this is the time to own basic materials stocks.  And we’re going to get into this sector through the iShares Dow Jones US Basic Materials Sector Index Fund(IYM).

Fundamentals:  A closer look at IYM

IYM holds 67 US basic materials stocks.  It includes stocks from the chemical, industrial metals & mining, mining, and forestry & paper industries.

The expense ratio is 0.47%.

The top five holdings and percentage weight for IYM are –

Company Name Ticker % Weight
Du Pont DD 10.51%
Dow Chemical DOW 8.05%
Freeport-McMoRan FCX 7.42%
Praxair PX 7.22%
Newmont Mining NEM 5.24%

Technicals:  The charts lead the way

IYM is on the verge of a major breakout.  As you can see, the long-term uptrend is converging with the shorter-term downtrend in a symmetrical triangle chart pattern.

A breakout out to the upside will confirm the uptrend is still in place.


What’s more, IYM is nearing a 200-day moving average crossover.  As you know, the 200-day often acts like a brick wall stopping promising rallies dead in their tracks.

It usually takes more than one attempt to break through this level.  And IYM has already tested the 200-day on several occasions this year.

Here’s the thing… Once IYM breaks out, it’s off to the races.  It’s like a tightly coiled spring ready to jump as soon as the lid comes off.  I think IYM is going to explode to the upside in short order.

Trade Alert

Buy:  iShares Dow Jones US Basic Materials Sector Index Fund (IYM) up to $70.00
Recent Price:  $66.98
Price Target:  $90.00
Stop Loss: $ 60.00

Remember:  IYM has a promising technical setup and is benefitting from a revival of economic growth.  Once it breaks through resistance, it’s going to be off to the races. I think IYM will eclipse the bull market highs set back in 2011.  However, if the breakout comes to the downside, we’ll cut our losses at $60.


Oil speculators have a bad image.

It’s no secret hedge funds and other institutional investors can influence oil prices with the huge bets they place on oil prices in the futures markets.

According to a study by Goldman Sachs (GS) last year, oil often trades at a premium of $10 to $30 above where it would if speculators weren’t betting on rising oil prices.

Here’s the thing…

Speculators don’t drive the overall trend in oil prices.  They amplify the trend.  In short, they make the upswings soar higher faster and downswings sharper and scarier.

For instance, when WTIC oil prices were at their peak of $110 per barrel in February, speculators net long position had ballooned to 272,000 contracts.  And by the time oil hit $80 in June, speculators had cut their net long positions to just 123,000 contracts.

A portion of oil’s dramatic swing from $110 to $80 was the direct result of speculators reducing their net long position.

But speculators don’t stay out of the game for very long.  As soon as oil prices began to climb in early June, the size of their net long positions began to increase.  And it’s amplifying the price gains in the commodity.

We still have a long way to go until speculators run out of steam.

Right now, speculators hold a net long position 152,000 contracts.  This is far cry from the 272,000 contracts they were net long back in February.

I’m expecting more speculators to pile into the oil trade as long as the fundamentals hold up.  And it will continue to fuel outsized price increases in crude oil.  And rising oil prices are good news for oil stocks.

Macro/Economic Trend:  Rising US Crude Oil Production

America’s oil production is experiencing a renaissance of sorts.  For the first time in nearly 30 years, US Crude oil production is on the upswing!


What’s behind the sudden resurgence in US oil production?

New drilling technologies are unlocking massive new oil reserves.  The Bakken shale in North Dakota is a perfect example.  It’s now a hotbed of oil drilling activity.  In fact, North Dakota is now the fourth largest onshore oil producer in the US, behind Texas, Alaska, and California.

And none of it would be possible without the expertise of oil services companies. They’re the ones with the technology that makes these unconventional oil reserves economically viable.

In other words, unconventional oil drilling puts a premium on oil service companies.

Here’s the bottom line…

The combination of a speculator fueled rally in oil prices and strong demand for oil services should fuel a massive rally in the SPDR S&P Oil & Gas Equipment & Services ETF (XES).

Fundamentals:  A closer look at XES

XES is a modified equal weight index.  The ETF is essentially equally weighted among 45 of the biggest and best oil & gas equipment & service companies.

The expense ratio is 0.35%.

The top five holdings and percentage weight for XES are –

Company Name Ticker % Weight
Exterran Holdings EXLP 3.68%
RPC RES 2.76%
Haliburton HAL 2.75%
Baker Hughes BHI 2.68%
Nabors Industries NBR 2.68%

Technicals:  The charts lead the way

XES is in a long term uptrend stretching back to the bear market low in March of 2009.

However, the rally in the first few months of 2012 failed to eclipse the 2011 highs. This sent the ETF spiraling downward from $40 in February to around $28 in late June.

But things have gotten better lately…


In a matter of weeks, XES has set a series of higher highs and higher lows.  And it’s established a new uptrend.

Now XES is on the verge of breaking through resistance at the 200-day moving average.  This is a bullish crossover.  Many investors see the 200-day as the line in the sand between uptrend and downtrend.  If XES holds above the 200-day through the end of the week, we’ll likely see this crossover attract new investors to XES.

We could see additional resistance around $36.  But after that it’s clear sailing back to the February highs.

Trade Alert

Buy:  SPDR S&P Oil & Gas Equipment & Services ETF (XES) up to $36.00
Recent Price:  $34.47
Price Target:  $40.00
Stop Loss:  $30.50

Remember:  XES has strong fundamentals and momentum on its side.  A series of higher highs and higher lows has established a strong uptrend off the June low.  As long as oil prices keep climbing XES should too.  And at this point it appears speculators will continue building their net long position in oil futures and spurring the rally along.

Consumer Discretionary (+4.8%)

Retail sales bounced back in July.  The 0.8% jump ended three months of declines. The strong showing has helped breathe new life into jittery investors.

There’s also been a noticeable uptick in consumer sentiment and the employment front.  That’s good news for consumer discretionary stocks.

Our SPDR S&P Retail Fund (XRT) had a solid month.  Obviously, strong retail sales and an improving jobs market will go a long way to lift this sector toward our price target.  Right now XRT’s quickly closing in on our buy up to price.  Grab your shares of XRT up to $62.50.

The SPDR S&P Homebuilder ETF (XHB) surged higher after building permits jumped 6.8% to 812,000 last month.  It was the first time permits have come in above 800,000 since August of 2008.  This is a clear indication new home construction is on the upswing.  XHB is now above our buy price so I’m moving it to a hold.

Consumer Staples (+2.1%)

Consumer staples stocks lagged behind consumer discretionary stocks as investors begin to take on additional risk.  At this point, the defensive dividend trade has become overcrowded.  And we’ll likely see this sector underperform as long as we don’t get any shocks to the system.

Energy (+8.3%)

Energy stocks came roaring back in a big way this month.  It was one of the top two performing sectors along with technology.

Obviously, the sector’s fate is tied to oil prices.  And right now oil prices are screaming higher.  This is just too good of a situation to pass up.  We’re recommending the SPDR S&P Oil & Gas Equipment & Services ETF (XES) to profit from further upside in oil stocks… see Trade Alert 2 for more details.

Our First Trust ISE Revere Natural Gas Index Fund (FCG) is racing higher.  It hit a new high of $17.24 last week.  And the ETF is holding up well despite natural gas prices slipping lower over the last few weeks.  All things considered, FCG has tremendous upside.  Continue holding for bigger gains.

The ALPS Alerian MLP ETF (ALPS) has settled into a range between $16.15 and $16.55. But that’s just fine.  ALPS gives us a strong dividend play with growth potential from the build-out of the US energy infrastructure to boot.  Continue holding ALPS for further gains.

Financials (+3.1%)

Financial stocks are a mystery.  Many financial stocks are downright cheap.  But the industry continues to shoot itself in the foot with trading scandals, software glitches, and the like.  Until these companies give us a reason to trust them again, our capital is better off in sectors without these self-inflicted headwinds.

Healthcare (+0.7%)

Healthcare stocks are holding steady.  But they’ve lagged behind cyclical sectors over the last month.  But unlike some defensive sectors, healthcare stocks still have enormous upside.

Don’t forget, the entire industry struggled to gain traction because of the uncertainty created by Obamacare.  And like it or not, the Supreme Court’s decision to uphold the law has taken a lot of uncertainty out of the picture.

Our PowerShares S&P SmallCap HealthCare Portfolio (PSCH) is looking good. Continue holding PSCH for bigger gains ahead.

The iShares Dow Jones U.S. Pharmaceuticals Index Fund (IHE) has gotten off to a bit of a slow start.  But don’t be fooled, big pharma stocks have huge upside. They’ve done a good job of rebuilding their drug pipelines.  And baby boomers are just beginning to enter into their prime pill popping days.  Grab your shares of IHE up to $90.

Industrials (+7.4%)

Industrial stocks have snapped back recently.  Clearly, investors and analysts alike had become too bearish on the cyclical sector.  Now they’re playing catch up as economic growth begins to accelerate.

Our Guggenheim Airline ETF (FAA) has held steady over the last month.  And then it jumped higher yesterday after a report that Southwest Airlines (LUV) was raising ticket prices to offset higher fuel costs.  The airline industry has been very successful in passing along higher fuel costs to consumers lately.  And this price hike could be just the thing to jumpstart sluggish earnings growth.

The Market Vectors Agribusiness ETF (MOO) is off to a fast start.  Investors are realizing the corn destroying drought in the Midwest could be a boon for Agribusiness sales next year.  MOO is already above our buy price so I’m moving it to a hold.

Technology (+8.9%)

The fear of a slowdown in business tech spending has proven to be largely overblown. And as a result, tech stocks have come storming back.  They led all sectors with an 8.9% increase over the last month.

Our iShares S&P NA Technology-Software Index Fund (IGV) has made a big run over the last few weeks.  After all of the ups and downs, we’re currently up about 9% from our original buy price.  And there’s still plenty of upside.  Continue holding IGV…

Materials (+4.7%)

Materials stocks have finally found a bottom.  And they’ve begun to move higher again over the last few weeks.  Clearly, the improving macroeconomic outlook is helping the sector get back on the right track.

What’s more, investors are beginning to take on more risk.  They’re leaving the confines of their defensive investments in search of growth.  And materials stocks offer a solid combination of growth and value at these prices.  In fact, we’re recommending the iShares Dow Jones US Basic Materials Sector Index Fund (IYM) this month… see Trade Alert 1 for more details.

Utilities (-0.6%)

Over the last few years, the utilities sector has undergone some major changes.  There were three major mergers completed in the last year alone.  However, the government has begun to throw up road blocks to further industry consolidation.  This will likely leave the defensive sector lagging behind the market going forward.

Portfolio Changes

  • This month we’re buying IYM and XES.
  • Move Market Vectors Agribusiness ETF (MOO) to hold.
  • Move SPDR S&P Homebuilder ETF (XHB) to hold.


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