SET Monthly Issue December 2012
December 2012
Merry Christmas and Happy Holidays… Welcome to the final issue of Sector ETF Traderfor 2012.
One thing’s for sure, 2012 didn’t have a shortage of catalysts to drive market action. It’s been an exciting year full of twists and turns.
Some catalysts we’re positive…
For instance, the housing market is on the upswing after years of decline. It’s providing a boost to a host of businesses that have suffered mightily in recent years.
Homebuilders, home improvement retailers, building material manufacturers, and banks are all feeling the benefits of a healthy housing market.
And through it all, the Fed has been there with the easiest monetary policy in American history to lend support to the modest recovery.
However, the majority of catalysts have hurt more than they have helped… The headwinds to the market’s performance have come in many forms.
The European sovereign debt crisis, slowing Chinese economy, US Fiscal Cliff, POTUS election, healthcare reform, unrest in the Middle East, and natural disasters are just a few of the hurdles the stock market faced this year.
And they all played a part in creating uncertainty…
The uncertainty has led many businesses to invest less and hire fewer workers than they normally would have at this point in the recovery. It has constrained an otherwise strong economic recovery in the US.
But through it all, the S&P 500 has managed year-to-date gains of more than 16%. That’s an impressive feat to be sure.
More importantly, the upswing in the market has been good to our ETFs. We sold a total of 17 ETFs this year with annualized gains of 26%. What’s more, eight of our nine active positions are up.
Clearly, our sector rotation strategy is providing solid returns. And I’ve got two more ETFs for you this month that should build on our strong track record.
I’m sure everyone has heard the old saying… money doesn’t grow on trees.
I know it’s become a staple of my vocabulary as a parent. It’s an easy way to shut down the kids when they ask for toys or video games when we’re shopping.
But for companies in the timber industry, it’s an entirely different story. For them, money really does grow on trees.
Macro/Economic Trend: Supply And Demand
The timber industry’s largest end market is new home construction. A typical US home uses about 16,000 board feet of lumber.
So the resurgence of the US housing market is a welcome sign for the industry.
As you know, US homebuilders are ramping up construction as Americans take advantage of record-low borrowing costs to purchase new homes.
In fact, US housing starts rose to their highest rate in more than four years in October. And homebuilder confidence is at a six year high as well. That bodes well for a full blown revival of new home construction in 2013.
Obviously, the demand for lumber should mirror the upswing in new home construction as well.
In fact, lumber mills are already operating at the fastest pace in four years. And many have plans to restart capacity that has been sitting idle for years.
At this point, demand is growing faster than supply. Prices for logs and cut lumber are on the upswing and are expected to continue rising throughout 2013.
Put simply, the outlook for the timber industry is extremely bullish. One ETF that should reap the rewards of the strong fundamentals in the timber industry is theGuggenheim Timber ETF (CUT).
Fundamentals: A closer look at CUT
CUT tracks an equity index called the Beacon Global Timber Index. The Index is designed to follow stocks of global timber companies. In order to be included in the index, the company must own or lease forested land and harvest the timber for commercial use and sale. It currently holds 28 stocks.
The expense ratio is 0.65%. And it has an annual dividend yield of 1.92%.
Currently, the top five holdings and percentage weight for CUT are –
| Company Name | Ticker | % Weight |
| West Fraser Timber | WFT | 6.05% |
| Weyerhauser | WY | 5.57% |
| Fibria Celulose ADR | FBR | 5.47% |
| Smurfit Kappa (I) | SKG | 5.40% |
| Svenska Cellulosa (I) | SCAB | 5.01% |
Technicals: The charts lead the way
As the housing market heated up over the last few months, so has CUT.
As you can see in the chart below, a new uptrend has emerged (red line) off of a triple bottom.
CUT also recently broke out above resistance (green line) of the March highs that had been a roadblock over the last few months.
This is a clear indication CUT is building momentum. And it should continue to fuel a strong surge that should carry it back to the 2011 highs and beyond.
Trade Alert
Buy: Guggenheim Timber ETF (CUT) up to $21.00
Recent Price: $20.14
Price Target: $23.50
Stop Loss: $18.00
Remember: CUT is in a strong uptrend and recently broke out above resistance. But it wouldn’t surprise me to see CUT pull back to support around $19.00 before resuming the uptrend. You could potentially reap bigger profits if you wait for CUT to pull back to this level before buying. Just keep in mind that there’s no guarantee CUT will pull back and you could risk missing out on this trade all together. Either way, this trade should produce sizeable profits as CUT surges higher.
Financial stocks and banks in particular have been among the most hated investments in the wake of the 2008 financial crisis. I know I’ve been wary of recommending ETFs with direct exposure to this industry for years.
On the rare occasion I have recommended them, it has been a trade based on a chart pattern or technical setup rather than fundamental improvement in the sector.
And this month’s recommendation of the SPDR S&P Bank ETF (KBE) is no different. But there has been some improvement in the industry fundamentals recently. Those improvements should help fuel a strong rally in KBE in the weeks ahead.
Macro/Economic Trend: Invest In Yourself
Banks are coming off the best quarter in six years. Overall, banks saw earnings rise 7% in the third quarter from the same time last year.
They accomplished this by adjusting their business models to the new regulatory environment and setting aside less money for bad loans. They’re also generating a stream of income by originating mortgage loans and quickly selling them to the government.
The result is a banking industry with stronger balance sheets and smaller loan portfolios.
Despite these improvements, investors have been slow to pour their hard earned money back into the sector. The risks the fiscal cliff and ongoing sovereign debt crisis in Europe pose to the financial system have kept optimism in check.
The combination of cheap bank stocks and healthy bank balance sheets creates an interesting opportunity for banks to boost EPS without lending more money.
You guessed it… stock buybacks.
The Federal Reserve is starting to allow banks to repurchase stock. And judging by the high levels of cash on banks’ balance sheets, they’re chomping at the bit to repurchase massive amounts of stock at these depressed prices.
If the Fed gives them the green light to increase these programs, they could help fuel a strong rise in earnings per share. And they could do it without increasing the size of their loan portfolio.
The bottom line is banks have the potential for tremendous per share earnings growth.
Fundamentals: A closer look at KBE
KBE tracks the S&P Banks Select Industry Index. It’s a modified equal-weighted index that seeks to reflect the performance of publicly traded companies that do business as banks or thrifts. The ETF holds 41 bank stocks.
The expense ratio is 0.35%. And the dividend yield is 1.83%.
The top five holdings and percentage weight for KBE are –
| Company Name | Ticker | % Weight |
| Ocwen Financial | OCN | 3.43% |
| Bank of America | BAC | 3.09% |
| Citigroup | C | 3.01% |
| Popular | BPOP | 2.96% |
| Bank of New York Mellon | BK | 2.88% |
Technicals: The charts lead the way
The macro trend is important. But this trade is really about the chart…
KBE has been consolidating for nearly two years. It’s been in a downtrend off of the highs it reached in early 2010. But it has also been in an uptrend off the late 2011 lows.
As you can see in the chart below, the price action forms a chart pattern called a symmetrical triangle. This pattern is neither bullish nor bearish. It simply implies that there has been indecision in the market.
But as the red resistance line converges with the green support line, it indicates this period of indecision is quickly coming to an end.
At this point, it all depends on which way the break comes. If KBE breaks through the red resistance first, it should soar. But if it breaks the green support, it could quickly tumble back to 2012 lows.
Any way you slice it, once KBE breaks out of this pattern, the move is likely to be fast and furious.
Trade Alert
Buy: SPDR S&P Bank ETF (KBE) up to $24.50
Recent Price: $23.85
Price Target: $29.00
Stop Loss: $22.00
Remember: This chart pattern is still unresolved. If it breaks support first, it could quickly turn against us. Just in case we’re wrong, I’m using a tight stop loss to keep our losses to a minimum. On the flip side, the rewards could be rich if KBE breaks out to the upside of the consolidation pattern.
Consumer Discretionary (+3.7%)
Consumers are shopping ‘til they drop… or until their hand can’t click on any more websites… this holiday season. As a result, consumer discretionary stocks bounced back this month after a two month slide. But with the fiscal cliff still looming, we took the opportunity to lock in our profits on ETFs in this sector earlier this month.
Nevertheless, the sector could produce some sizeable gains in 2013 if the fiscal cliff is avoided.
Consumer Staples (+4.5%)
In the wake of the post election market selloff, consumer staples stocks became extremely oversold. That’s when we bought the Consumer Staples Select Sector SPDR (XLP). Since then, XLP has gained about 5%. And it should continue to add to those gains in the weeks and months ahead. XLP is flirting with our $36.00 buy up to price. Go ahead and buy them on any dip below this level.
Energy (+5.5%)
Commodity traders have taken a wait and see attitude as the US approaches the fiscal cliff. As a result, we’ve seen WTIC oil prices settle into a trading range between $84 and $90 per barrel. And that likely won’t change until next year.
Our SPDR S&P Oil & Gas Equipment & Services ETF (XES) has rebounded to near our initial recommendation price. If the fiscal cliff is avoided, it could spark a nice rally in oil prices as well as XES. Buy XES up to $36.00.
The ALPS Alerian MLP ETF (AMLP) has been volatile in the wake of President Obama’s reelection. Investors have been wary of the impact higher taxes on dividends will impact the fund’s returns. But I’m confident AMLP will continue to deliver better income than can be found in other investments. AMLP is currently below our $16 buy up to price so feel free to buy at these levels.
Financials (+4.7%)
We’re showing the financials some love this month… We’re recommending the SPDR S&P Bank ETF (KBE) this month in hopes of a technical breakout in banking stocks. See Trade Alert 2 for more details…
Healthcare (+4.1%)
Healthcare stands to be one the best performing sectors in 2012. A feat that could be repeated in 2013 now that President Obama has won reelection and healthcare reforms are implemented.
Our iShare Dow Jones U.S. Pharmaceuticals Index Fund (IHE) has struggled to produce the types of gains we had hoped for right off the bat. But IHE has clawed its way back near our initial buy price. And it’s in position to build off of that bullish momentum in the weeks ahead. Grab you shares up to $90.
Industrials (+5.9%)
Industrial stocks were the strongest sector of the market last month. It reversed a two month trend of losses in industrial stocks.
Our Market Vectors Agribusiness ETF (MOO) was among the strongest ETFs in the sector. MOO is now at its highest levels in months and up 8% since we recommended it. It appears to be on its way to challenging the 2012 highs around $52 in short order. Continue holding for bigger gains.
Technology (+3.7%)
Tech stocks are battling strong headwinds from the weak performance of bellwetherApple (AAPL). The consumer electronics giant’s stock has been in a virtual free fall since reaching $700 in September. The stock nearly hit $500 earlier this week. That’s nearly a 30% slide in the stock price.
If tech has any hope of getting back on track, APPL simply must regain some of the momentum that fueled its rise over the last four years.
Our First Trust Internet Index Fund (FDN) has had a nice run in recent weeks. It’s now on the verge of breaking out to a new 52-week high. But first it needs to clear resistance around $39 that has turned FDN back three previous occasions. Buy your shares up to $39.50.
Materials (+5.1%)
Materials stocks spent much of 2011 and all of 2012 in a trading range. Weakness in the global economy, especially China, has hurt growth.
But economic data indicates China could be on the verge of rebounding. And if the US avoids the fiscal cliff, it could reignite investors’ animal spirits and spur them to move into more cyclical stocks in hopes of bigger gains in 2013. Our iShares Basic Materials ETF (IYM) is on the upswing. Make sure to grab your shares up $70.00.
What’s more, the resurgence of homebuilding in the US should drive solid profits in materials stocks geared toward new home construction. In fact, we’re recommending the Guggenheim Timber ETF (CUT). See Trade Alert 1 for more details…
Utilities (+2.5%)
Utilities 2.5% gain was the weakest sector gain over the last month. And it should continue to underperform more cyclical sectors going forward. I’m steering clear of this sector for now.
- This month we’re buying CUT and KBE.
Category: SET Monthly Issues
