SET Monthly Issue December 2011

| December 20, 2011

December 2011


The New Year is right around the corner.  And the question on everyone’s mind is… will stocks get a Santa Claus rally?

I’m afraid the odds aren’t looking too good.

There are only seven trading days left before we close out this wild year.  And the European debt crisis is just too overpowering for the bulls to manufacture a strong close to 2011.

But don’t fret… we’ll get our chance in 2012.

As the calendar turns another page, the doom and gloomers will learn that time marches on.  And I believe the markets will too.

As they say, time heals all wounds…

The scars of the financial crisis cut deeply.  But many of the reasons that lead to the crash are now in the rearview mirror.  So, it’s not 2008 all over again.

The truth is… there’s a lot to be excited about.

First off, the European debt crisis will be resolved in the coming year.  One way or another, Europe will start to get their house in order.

And even though the stock market has seen sharp declines and long periods of consolidation in 2011, history tells us these moves are always temporary.

Remember, what drives the stock market in the long run is the business cycle!
And right now we’re nearing a trough in the domestic business cycle.  That means the phase of slowing growth is ending and a new phase is just beginning.  I’d bet the farm the business cycle goes into expansionary mode in the year ahead.

And that spells economic recovery and growth for 2012.

Here’s why…

One of the biggest problems keeping a lid on economic growth is high unemployment. But it won’t be a problem much longer.  As companies enter the expansionary phase of the business cycle, they’re going to need one important ingredient… a larger workforce.

It makes sense… a company can’t boost productivity very much if they don’t have enough employees to handle the additional workload.  So, look for business to finally open their doors and put Americans back to work.

Of course, this will be a huge win for the markets.  As we all know… jobs are a key ingredient for the economy.  Job growth will lead to higher consumer confidence levels.  And higher consumer confidence should prompt a big increase in consumer spending across the board.

And as confidence and spending increase, the economy keeps on growing.  That’s the beauty of the business cycle!

Here’s the bottom line…

2012 is shaping up to be a great year for the economy and the market, especially for sectors and ETFs that have been overlooked lately.

And I have two ETFs to start the New Year right.


Would anyone disagree that the housing market has been tough the last few years? Of course not, it’s been a nightmare.

We all know the story… a perfect storm of greed and stupidity destroyed the US housing market.

But I’m drawing the line right here!  That’s right, I’m looking at a brighter future for residential real estate.

And I’m not the only one… Warren Buffet, one of the world’s greatest investors, agrees with me.

A few months ago, the Oracle (Buffet’s nickname) revealed on CNBC that he made a bet with world famous economist, Peter Orszag.  The bet was that a recovery in the housing market would drive unemployment below 8% before the 2012 elections.

Clearly, Buffet sees better days ahead for the housing market.

Macro/Economic Trend:  Building For The Future

It’s no secret that housing is impacted by a number of factors.  The good news is many of these factors are turning positive right now.

Here are three reasons why I think we’ll see a housing recovery next year.

As you know, one key to a strong housing recovery is employment.

It just so happens, the most recent unemployment number was the lowest number in a long time.  The US Labor Department said the unemployment rate officially fell from 9.1% to 8.6% in November.

As more people get back to work, we should see demand for housing go up.

In addition, we’re seeing a significant drop in overall housing inventory.

It’s been a long time since we’ve seen that kind of steep decline!  And it bodes well for home values.  As the number of available homes falls, prices should start to climb.

Lastly, building permits and housing starts are showing signs of life.

According to last month’s report, building permits and housing starts were up a staggering 16% year over year.  And just last month, the Housing Department reported a 9.3% jump in housing starts.

Homebuilders have been holding off on new construction for two years now.  If they’re applying for more building permits and starting construction of more new homes, they must have a more bullish outlook for the year ahead.

No question about it, the housing market is showing signs it’s ready to rebound in 2012.

So, how can you profit from the turnaround in the housing market?

The best way is to go long the SPDR S&P Home Builders ETF (XHB).  This ETF is a basket of the strongest homebuilding and related companies.  They’re poised to move higher as the housing market improves.

Fundamentals:  A closer look at XHB

XHB holds 33 of the top US homebuilding companies.

The expense ratio is 0.35%.

The top five holdings and percentage weights for XHB are-

Company Name Ticker % Weight
Ryland Group RYL 4.50%
Lennar LEN 4.25%
Pulte Group PHM 4.10%
Lowe’s LOW 4.00%
Select Comfort SCSS 3.90%

Technicals:  The charts lead the way

Don’t look now, but XHB is in an uptrend…


Since October, the XHB has set three higher highs and three higher lows.  In fact, the ETF is up 37% from the early October lows.  That’s an uptrend if I ever saw one.

What’s more, the trend should continue for weeks and possibly for months to come. The 50-day moving average is providing strong support for the upward move.  And there’s little overhead resistance to keep XHB from moving higher.

Once XHB breaks through the $17 level, it should quickly move up to our target price of $19.

Trade Alert

Buy:  SPDR S&P Home Builders ETF (XHB) up to $16.75
Recent Price:  $16.13
Price Target:  $19.00
Stop Loss:  $14.50

Remember:  XHB is in a bullish uptrend.  The European debt crisis is coming to an end.  Unemployment and housing inventories are falling.  Plus, building permits and housing starts are picking up steam.  All signs point to a stronger overall housing market and higher prices for the stocks that make up the XHB.


Biotechnology’s one of my favorite businesses.

These fascinating companies are at the epicenter of groundbreaking new medical treatments.  They’re developing drugs to battle just about every disease known to man.

In just the last year, biotech companies have released blockbuster new treatments to battle cancer, hepatitis, lupus, and many other diseases.

As you might imagine, biotechs rake in cash hand over fist when one of their drugs is approved.  But it’s never that easy…

Macro/Economic Trend:  More Mergers & Acquisitions

It’s no secret biotechs run an intimidating gauntlet to get a new drug approved by the FDA.

Each drug is put through extensive clinical trials to prove its safety and effectiveness. And even if the trials are successful, it’s often a crapshoot whether the FDA will approve the drug.

Once a company gets a drug approved, they still have plenty of work to do.

For instance, production facilities need to be built and FDA approved… marketing needs to get the drug into the hands of doctors who can prescribe it… patients need to be educated about the drug…

You get the idea.

No question about it, the business side of bringing a new drug to market can be just as harrowing as the FDA process.

What’s more, if the drug’s sales don’t live up to investors’ lofty expectations… watch out! Investors will usually pound the sector into the ground.

Over the last year, a number of mid-cap biotechs with promising new drugs have failed to live up to expectations.  Some had problems with the efficacy of the drug.  But more often than not, it was because they didn’t sell enough of the drug.

As a result, a number of small and medium size biotech companies have seen their stock prices get crushed.

This is great news…

Remember, large pharmaceutical and biotech companies have a number of drugs coming off of patent protection.  They need to rebuild their product pipelines immediately.  And the easiest way to do that is to buy smaller biotechs with drugs ready to market.

What’s more, many of those same biotechs are trading at a fraction of what they were earlier this year.

The result?

Get ready for an M&A bonanza in the biotech industry next year.  There’s just no way the large drug companies can resist snapping up these smaller companies (and their drug development pipelines) while they’re on sale.

As M&A deals get done, the valuation of the entire industry is bound to skyrocket. The biotech ETF I believe will benefit the most is the First Trust NYSE Arca Biotechnology Index Fund (FBT).

Fundamentals:  A closer look at FBT

FBT is an equal dollar weighted index.  It puts 5% of its assets into 20 different biotech stocks.  The holdings are then rebalanced on a quarterly basis.

As an equal dollar weighted index, FBT puts a bigger emphasis on small and medium sized companies.  And those are the ones who should benefit the most from M&A.

The expense ratio is 0.6%.

The top five holdings and percentage weight for FBT are –

Company Name Ticker % Weight
Nektar Therapeutics NKTR 6.04%
United Therapeutics UTHR 5.88%
Qiagen N.V. QGEN 5.80%
Biogen Idec BIIB 5.74%
Amgen AMGN 5.70%

Technicals:  The charts lead the way

Biotech stocks were hit hard in the market selloff earlier this year.

As you can see, FBT is down more than 30% from its 52-week high.  And unlike large biotech stocks, the smaller biotech stocks that dominate FBT haven’t bounced back.


In fact, FBT has fallen back to the 2010 lows.  But that’s good news!

Right now, FBT is at a long term support zone.  The $30 level was resistance in 2009, but it became support in 2010.  I believe the $30 level marks the lowest we’ll see FBT go in 2011.

And in 2012, we’ll see FBT rocket higher as money floods back into biotech.

Trade Alert

Buy:  First Trust NYSE Arca Biotechnology Index Fund (FBT) up to $32.00
Recent Price:  $30.66
Price Target:  $44.00
Stop Loss:  $24.75

Remember:  FBT is just above a long term support zone at $30.  So we should see it move higher from here.  But it might not happen until we see a few M&A deals get done.  The good news is I think we’ll see plenty of M&A activity early on next year.  Go ahead and buy FBT up to $32.00.


Consumer Discretionary (-4.0%)

According to the National Retail Federation, shoppers spent a whopping $226 million over the Black Friday weekend.  This was up 1% from $212 million spent last year.

That’s great news for retailers…

Retail sales continue to be a bright spot in the economy.  They increased 0.5% in October.  A bit slower than September’s 1.1% gain, but a strong showing none-the-less.

And it’s continued good news for our SPDR S&P Retail Fund (XRT).  It was down slightly to $51.49 this month.  But I believe we’re still on our way to our $65 price target.  Continue holding for bigger gains ahead.

Consumer Staples (0%)

Stocks in the Consumer Staples sector are performing in their traditional defensive role.  They’ve held up well as the broader market came under pressure over concerns about the debt crisis in Europe.

The good news is… Staples’ earnings are expected to continue the uptrend from last quarter.

Our Consumer Staples Select Sector SPDR Fund (XLP) is holding steady.  That’s great in this chaotic market.  Continue holding for bigger profits ahead.

Energy (-8.5%)

Energy companies were some of the hardest hit stocks over the past month.  The sector’s down a tough 8.5% as a result.

The fortunes of energy stocks are usually tied to oil.  However, there seems to be a disconnect between oil prices and energy stocks this month.  Oil is still holding steady right around $100 a barrel, but energy stocks are down heavily.

We’re not ready to jump into energy stocks just yet.  But, I’m definitely keeping the sector on my radar…

Financials (-5.2%)

Financial stocks have been on a roller coaster ride all year.  And as long as the European debt crisis lingers, I will continue to stay away from this sector.

Our iShares FTSE NAREIT Residential Plus Capped Index Fund (REZ) has been holding on to nice gains.  We’re currently sitting on profits of more than 10%. Continue holding REZ for bigger gains ahead.

Healthcare (-2.0%)

Economic indicators show health care spending growth ticked down last month. What’s more, health employment in November showed below-average growth of 17,000 jobs.

In addition, total healthcare spending fell again, brought down by slower growth in hospital, physician services, and nursing home spending.

While I expect the sector to continue slowly creating jobs, the spotlight will remain dim as some non-health employment picks up steam first.

So, healthcare stocks (other than biotechs of course) are still off-limits in my book.

Industrials (-4.0%)

Industrial stocks had a tough go of it last month.  This sector is clearly range bound right now.  And I don’t see that changing in the next few weeks.

It will be interesting to see if industrials can regain their momentum as Europe continues to struggle.  For now, I’m taking a wait and see approach…

Technology (-4.5%)

Technology stocks have moved a bit higher lately.  But they ran into technical resistance this month.  BlackBerry-maker, Research In Motion (RIMM), just reported their third quarter 2012 financials.  The company provided a grim outlook.  As a result, shares of RIMM fell $1.15 (7.60%).

But there’s some good news…

Last quarter, two-thirds of all tech stocks beat earnings estimates.  And more than 7.5% of them raised guidance.  This bodes well for tech stocks as we move into 2012.

Our SPDR S&P Semiconductor ETF (XSD) has slipped from $49 to $42.50 after a few semiconductor companies slashed their 2012 earnings guidance.  That’s never good… However, the worst is already priced into our ETF.  Keep an eye on our stop loss at $39, but I’m expecting XSD to move higher from here.

The iShares S&P NA Technology-Software Index Fund (IGV) has also slipped a bit. But IGV is still in a strong uptrend.  And the earnings outlook for software companies remains strong.  Continue holding for bigger gains ahead.

Materials (-7.5%)

There was a time when it was easy to make money in gold and silver.

When inflation heated up… gold and silver went up.  When inflation calmed down… gold and silver drifted down.

When there was a geopolitical crisis… gold and silver spiked up.  When the crisis calmed down… gold and silver came down.

But lately, those correlations have broken down.  Now precious metal prices are fluctuating as investors move from a “risk on” to “risk off” trade and back to “risk on”.

Our one ETF in this sector is the Market Vectors Gold Miners ETF (GDX).  It’s largely moving in lock step with gold prices.  In the past few weeks as gold prices have fallen from $1,800 to $1,600 an ounce, GDX has gone from just over $60 per share down to $52.68.  Keep an eye on our stop loss at $50.  If GDX closes below $50, that’s our cue to sell.

Utilities (-2.2%)

With only a couple of weeks left in the year, there’s little debate it’s been a rough year for most investors.  I don’t know if anyone thought the utilities sector would be the strongest performer for the year.

What’s more, recent price and volume action in the Utilities Select Sector SPDR Fund (XLU) indicates even more upside potential.  If the year to come bears any resemblance to this year, there’ll be more money to be made in this sector.

As of Thursday’s close, the Select Sector SPDR (XLU) is up 10.47% compared to the 2.73% decline in the S&P 500.  In total, the XLU has outperformed the S&P by 13% year to date.

And we’re still collecting a solid 3.99% annual dividend.  Continue holding for bigger gains ahead.

Portfolio Changes

  • This month we’re buying XHB and FBT
  • Moving IGV back to a buy up to $59.00


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