SET Monthly Issue February 2010

| February 16, 2010

February 2010


The stock market’s made its first significant correction since it began an incredible rally last March.

There’s been no place to hide as every sector in the S&P 500 fell in the last month.  In fact, the S&P 500 is now back at levels we first hit in September ’09.

Still, a 9% correction after a 72% rally is pretty mild.

It’s important to remember, nothing goes straight up forever.

Nevertheless, it’s frustrating to watch some of our hard fought gains disappear.  It’s all the more frustrating when economic data supports our view… The world economy is getting stronger.

The catalyst for the recent pullback is a combination of fundamental and technical factors.

On the fundamental side, separate events in Europe and China stirred up investor fear.

In Europe, the PIIGS countries have come under fire for their ballooning budget deficits and public debts.  Governments in Portugal, Italy, Ireland, Greece, and Spain are running up debts at an unsustainable pace.

Without serious reforms, these countries could default on their debt.  And that would trigger another debt crisis.  Much like when Lehman Brothers failed back in 2008.

Then news out of China hit the wires.  The central bank is moving to restrain lending. They’re increasing the amount of deposits banks must hold as reserves.  This cuts down on the amount of money banks can lend… and cools the economy.

The fear is the Chinese central bank will hit the economic breaks too hard.  And a significant slowdown in China’s economy could derail the global economic recovery.

These real world concerns coincided with several bearish technical indicators.  I discussed the technical chart patterns in February’s portfolio update.  So I won’t rehash them again.  Let’s just say it pointed toward a short term correction.

The result is, everyone from technical traders to fundamental investors had a reason to sell.  I think the bad news and lowered expectations are now priced into stocks. And the bearish chart patterns have played out.

The fear is subsiding.  And investors are once again looking for a reason to put money into the markets.  I think they’ll find it as their focus is shifting back to the future.

Macro/Economic Trend:  The Stuff Growing Economies Need

The building blocks of the world economy are the basic materials.  This sector includes companies who specialize in the mining and refining of metals, chemical producers, and forestry products.

These are the elements needed to support strong economic growth.  This makes them highly susceptible to investors’ mood swings.  So, when bad news puts the economic recovery in doubt, this sector gets hurt.

It makes sense that basic materials companies will see revenue and earnings miss expectations if the economic recovery doesn’t happen quickly.

At this point, I think investors have priced in a gloomy outlook for future economic growth.  Over the next few months, I expect real world results to exceed current expectations.

And when that happens, basic materials stocks will be flying high once again.

Remember, basic materials stocks perform well during the early to middle part of recovery in the business cycle.  And we’re still in the early stages of recovery.

The ETF I like to profit as investors move back into the basic materials stocks is theRydex S&P Equal Weight Materials ETF (RTM).

Fundamentals:  A closer look at RTM

RTM is an equal weight ETF.  It invests equal dollar amounts into 31 basic materials stocks.  The holdings are rebalanced quarterly.

The expense ratio is 0.5%.

Currently the top five holdings and percentage weight for RTM are –

Company Name Ticker % Weight
Airgas ARG 4.37%
CF Industries CF 3.79%
AK Steel AKS 3.59%
Dow Chemical DOW 3.47%
PPG Industries PPG 3.43%

Technicals:  The charts lead the way

XRTM has a good technical setup over multiple time frames.  The weekly, daily, and hourly charts all show the pullback is over.  RTM is once again ready to move higher.

First, the weekly candlestick chart shows a doji in the first week of February.  A doji looks like a cross on the chart.  It has long upper and lower shadows with no real body.  It indicates a possible reversal.  Our doji showed up at the end of three consecutive down weeks.  The reversal was confirmed when RTM closed up for the week on Friday, February 12th.

On the daily chart, RTM is beginning to recover from oversold levels.  The MACD and full stochastic both show bullish momentum is building.

And finally, the hourly chart.  Last week the 20-hour moving average crossed the 50- hour moving average to the upside.  This is bullish sign indicating interest RTM is building.

To top it off, RTM is showing relative strength compared to other ETFs tracking the basic materials sector.


All in all, the setup over multiple time frames indicates RTM should move higher over the next few months.

Trade Alert

Buy:  S&P Equal Weight Materials ETF (RTM) up to $51.25
Recent Price:  $49.71
Price Target:  $60.00
Stop Loss:  $45.75

Remember:  The markets are coming off the biggest correction since the market took off last March.  We could see the markets chop around at this level for a while before the bullish momentum resumes.  There is also a large overhang of selling pressure from investors who were trapped at the highs.  They’ll be looking to sell into any rally.  But once the selling pressure has been worked off, the basic materials sector should lead the markets higher.


Consumer Discretionary (-2.8%)

The impressive rally for consumer discretionary stocks moved the sector up 92% off the March low.  The rally officially came to an end last month.  It happened when the support line of the uptrend was broken as the market corrected.

Consumer discretionary stocks still have a lot of upside potential.  But investors need to see improvements in unemployment and housing to justify higher stock prices.  Our homebuilders ETF (XHB) has been one of the best performing sector ETFs so far in 2010… so hold tight for more gains to come.

Consumer Staples (-1.2%)

The consumer staples sector held up better than most sectors as the market corrected.  But this sector’s performance is nothing to write home about.  It’s been trading in a tight range the last four months.

As the economic recovery becomes more mature, the rapid market gains we saw for much of ’09 will slow.  This should cause the staples to rise at a pace closer to the overall market going forward.  But I don’t see this defensive sector dishing out outsized gains anytime soon.

Energy (-6.2%)

Oil has settled into a trading range between $70 and $80 over the last four months. The lack of direction in oil prices has kept the energy sector’s performance in check.

The big picture is, energy use will accelerate as the economic recovery continues to plod along.  But until there’s evidence the existing supply of crude oil is being consumed, energy shares could remain range bound.

Financials (-6.6%)

The pullback in the financial stocks has erased a sizeable portion of the sector’s gains.  They’re now back at levels they hit in the early part of August.  More than likely, the financial sector will see a bounce back rally over the short term.

But looking out over the next year, I think financials will lag the rest of the market. The industry is facing increased government regulation.  The largest banks are staring down the barrel of a government firing squad.

This could be good news for the smaller banks in a different situation.  But the smaller banks are facing their own issues.  By and large, their loan portfolios are loaded with bad commercial and residential real estate loans.  They’re just not in a position to profit from their larger brethrens misfortune.

Healthcare (-4.2%)

The political debate surrounding healthcare continues to drag on.  Unhealthy partisan bickering on the topic is bad for everyone involved.  With any luck, it will end with a few double talking career politicians being tossed out on their backsides come election time.

As long as the debate continues in Washington DC, investors on Wall Street will be hesitant to embrace the healthcare sector.  The uncertainty is another layer of risk most investors don’t want to deal with.  Despite the sector’s political issues, our biotech ETF, First Trust NYSE Arca Biotechnology Index Fund (FBT), is off to good start.  It’s the one shining light of hope in an otherwise dark industry.

Industrials (-5.2%)

Business conditions for the manufacturing industry continue to improve.  And the entire industrial sector has the potential to rocket higher as the economic recovery continues.

The sector has held up better than most as the market corrected.  As fear over a slowing Chinese economy wanes, our industrial ETF (VIS) should be poised for another run toward our price target.

Technology (-5.7%)

The technology sector is poised to lead the markets higher once again.  Many of the bellwether technology companies like Intel (INTC), Microsoft (MSFT), and Cisco(CSCO) posted better than expected Q4 earnings.  And it didn’t hurt when their management teams said they see this as the early stages of a new cyclical trend of growing sales and earnings.

Despite the great earnings season, tech shares have sold off with the rest of the market.  Now tech stocks are some of the first to start moving higher as the market bounces back from oversold conditions.  I expect tech to continue to lead the markets as bullish momentum returns.

Materials (-8.4%)

The basic materials sector mirrors the expectations for the world economy.  And over the last month, those expectations took hit.  As a result, the basic materials ETFs have taken a hit too.

But I think the pullback’s been overdone.  Materials stocks will bounce back quickly. We’re recommending the Rydex S&P Equal Weight Materials ETF (RTM)… see above for details.

Utilities (-6.8%)

Utility stocks have been punished lately.  It’s really a case of bad timing.  Utilities were one of the hottest sectors closing out ’09.  Then the entire market fell apart. And then a massive snowstorm knocked out power and caused damage across the US. It’s been a rough few months for the normally low volatility utilities sector.

Utilities Select Sector SPDR ETF (XLU) has pulled back a bit and is nearing our stop loss.  It appears that XLU is poised to move higher after finding support at the 200-day moving average.  But keep an eye on your stop loss..

Portfolio Changes

  • This month we’re buying RTM…

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