SET Monthly Issue February 2012

| February 21, 2012

February 2012


This market is on fire!  There’s no doubt we are on the verge of a major breakout. With just six weeks of trading under our belts, all the major stock averages are trading at or near 52-week highs.

So far this year, the NASDAQ is up 13.3%, the S&P 500 is up 8.24%, and the Dow is up 6%.  It truly doesn’t get much better than this.

Buckle up, because this rally is about to accelerate…

You see, we’re nearing the 52-week high for the S&P 500.  As of Friday’s close, the S&P sits just nine points away at 1,361.23.  And with the Dow and the NASDAQ already at 52-week highs, it’s looking like we’re certain to see a major breakthrough.

As you know, it’s fundamentals that truly matter.  And they’re the driving force behind the continuing move higher.

The fact is, US economic data is consistently improving.  We’re seeing virtually every major economic indicator pick up.

For starters, the unemployment rate has fallen from 9.1% a year ago, to just 8.5%.  In addition, jobless claims are finally under the 400K level for the past two months in a row.

As you know, job growth is a good sign companies need more workers.  As companies move into the expansionary phase of the business cycle, they need a bigger workforce to handle the additional workload.  Obviously, a company can’t improve productivity with an inadequate staff.

Therefore, unemployment dropping to 8.5% is a great signal the economy is finally turning.

While strong employment is the foundation of the US economy, manufacturing is critically important as well.  And the latest ISM manufacturing data is pointing higher.

In January, the PMI survey rose to 54.1%.  This represents an increase of 1 percentage point from December’s seasonally adjusted reading of 53.1%.  All in all, that’s the 30th straight month of expansion in the manufacturing sector.

As both employment and manufacturing are on the rise, there’s only one thing keeping the major US stock indexes from finally breaking out… the sovereign debt crisis in Europe.

There’s no doubt you’re aware of the chaos ensuing in Greece and the EuroZone.  It’s all over the news.  Unfortunately, many investors are on the sidelines right now.  In fact, there’s still over $2.65 trillion still sitting in money markets.  And it’s all due to fear of a catastrophic financial event, which may be caused by a Greek default.

But, with the hard work of the EuroZone leaders, the ECB, and the IMF… catastrophe may be averted.

You see, the ECB has put a kind of firewall between a Greek default and the EuroZone’s banks.  The long-term refinance operation run by the ECB has set the European banking system up to better withstand a default by Greece.

Here’s the upshot…

US markets have rallied while focusing on the improving US economy.  But there’s more room left for stocks to climb.  As soon as we learn Greece has finally avoided default and will stay in the EuroZone, the markets will surge higher.

Now, I have two ETFs set to take advantage of a breakout rally.


As the economy continues to improve, we’re looking at a pickup in capital expenses. That means industrial goods will once again lead the markets higher.

If you’re not familiar with the industrial sector, think big.  Aerospace, textile, machine tools, lumber, heavy construction equipment, and farm machinery are all in the industrial sector.

You see, as the economy expands, spending in all of these sectors will increase to enable further business growth and productivity.

In fact, Caterpillar (CAT) just announced they’re building a new $200 million factory right here in the US.  Their new 1 million square-foot plant will be making small bulldozers and excavators, which are typically used in construction and demolition projects.

If you need a signal we’ve reached a bottom in industrials, CAT’s big ticket spending gives us a clear indication the industrial sector is ready to grow once again.

Macro/Economic Trend:  The Industrial Sector Is Ready To Breakout

When we look at the sector rotation model, we can see the industrials have bottomed.  More importantly, their performance over the past six months is a clear signal they’re heading higher.  So far this year, the industrial sector is up by 12.9%.

If you think we’ve missed the move in the sector, you couldn’t be more wrong…

If we move out to a one year view, you’ll find that the industrial sector is sitting at roughly break even.  And that provides us a great opportunity to catch the next wave higher.  Remember, we’re sitting at new 52-week highs in the Dow Jones Industrial Average.  Better still, we’re just 3% from a three-year high in the sector.

With ISM manufacturing numbers heating up, you can bet the rally is primed to continue for industrials.  Better still, orders for US durable goods climbed more than forecast in December, rising 3%.  That’s after a 4.3% jump the month prior. It’s all pointing to a rebound in business investment that will help drive the US economy in 2012.

In addition, the index of leading indicators rose for a third straight month in December.  According to a report from the New York-based Conference Board, their outlook for the next three to six months increased 0.4 percent after climbing 0.2 percent in November.

The bottom line…

There’s still great opportunity to benefit from the pickup in industrial activity.

So, how can you profit from the surge of industrial demand?

The best way is to go long the Industrials Select Sector SPDR ETF (XLI).  This ETF is a basket of companies in industries ranging from aerospace and defense to construction and engineering.  And they’re set to rally as the economy expands.

Fundamentals:  A closer look at XLI

XLI holds 61 of the top companies in the industrial goods sector.  The index includes companies from industries such as aerospace and defense, building products, construction, electrical equipment, conglomerates, machinery, commercial services, and supplies.

The XLI carries a 1.95% dividend yield.

The expense ratio is 0.18%.

The top five holdings and percentage weights for XLI are-

Company Name Ticker % Weight
General Electric GE 10.72%
United Technologies UTX 5.61%
Caterpillar CAT 5.59%
United Parcel Service UPS 5.36%
3M MMM 4.48%

Technicals:  The charts lead the way

It’s clear, the XLI has bottomed and continues moving in an uptrend…


Since October, the XLI has continued to climb almost non-stop.  With just two small corrections, the ETF surged over 35% off its October lows.  Clearly, we’re looking at a solid uptrend here.

What’s more, the trend should continue for months to come.  We have strong support for the upward move, as XLI remains above the 50-day moving average.  And as soon as the XLI breaks the 52-week high of $38.31, we’re sure to see this ETF continue making new all-time highs.

Once XLI breaks through the $38 level, it should steadily move up to our target price of $45.

Trade Alert

Buy:  Industrials Select Sector SPDR ETF (XLI) up to $38.25
Recent Price:  $37.28
Price Target:  $45.00
Stop Loss:  $31.00

Remember:  XLI is in a strong bullish uptrend.  US manufacturing and industrial production are picking up.  Also, we’re on the verge of resolution in the Greek debt crisis.  And all the stocks in the XLI are poised to rise.  Buy XLI up to $38.25.


It’s not sexy, but insurance can be a highly profitable business.

The job of insurance carriers and reinsurers is to collect more in premium than they pay out in claims.  When they do, it usually translates into a sweet profit.  Add to it the income they generate by investing the premium they collect and the sky’s the limit.

But the industry has had its share of trouble lately…

Now, over the past few years, the industry has struggled to remain profitable.  Due to the uncertainty in the global environment and the unknown impact of major catastrophes, a number of insurance carriers have reported steep losses.

And their shares have tumbled as a result.

Take for example Hartford Financial Services Group (HIG).  In 2009, the company lost $2.93 per share… and that was after losing a whopping $7.99 per share in 2008. To illustrate my point, HIG shares traded near $100 in 2007.  By March of 2009, they bottomed out near $3.33.  That’s nearly a 97% loss in two years.

However, in 2010, Hartford turned the corner and posted a $2.49 per share profit.  And HIG remains profitable in 2011.  But they’re estimated to post earnings of just $1.09 per share.

As a result, share prices have struggled to reflect their recovery to profitability.  And after reaching a high of over $30 in March of 2011, shares fell again to touch the $15 level.

But things are looking better for 2012.  Analysts are forecasting HIG will post a profit of $3.73 per share.  And it’s this type of jump in profit that makes the sector so attractive.  As you’d expect, shares are on the climb and are now trading near $21.65.

HIG is just one example of a number of insurance companies gearing up to meet healthy earnings forecasts for 2012.

And just like any industry that faces a difficult period, the insurance industry’s finally turning the corner.  So now’s a great time to jump back in.

Macro/Economic Trend:  Improved Risk Management & Capitalization Will Drive Profits

The insurance industry is improving risk management techniques and strengthening balance sheets to withstand uncertain events.  Not only does this help prevent a major impact to insurance carriers, but these actions help improve overall profitability.

In addition, many carriers are restructuring some of their product offerings and are reducing low profit products.  Medicare policies and annuities are just a couple of the underperformers.  With ultra-low interest rates appearing to be in place until 2014, these products will only hinder total return.

In fact, A.M. Best reports that many carriers are eliminating both fixed and variable annuities, as well as selling off non-performing divisions… such as banking.

For example, Allstate Financial is downsizing its annuity business and dissolving its bank.  In addition, MetLife, Pacific Life, and Kemper are either winding down or selling off their banking operations.  By doing so, these organizations can refocus their capital to more profitable products.

Interestingly, A.M. Best forecasts that multi-line insurance carriers are poised to be the most profitable of the bunch in 2012.

And I’ve found an ETF whose holdings include a host of multi-line companies… SPDR S&P Insurance ETF (KIE).

Fundamentals:  A closer look at KIE

KIE seeks to closely match the returns and characteristics of the S&P Insurance Select Industry Index.  The holdings are comprised of leading companies active in the US insurance industry.  The companies in KIE must be listed on a US exchange, such as the NYSE or NASDAQ.

The expense ratio is 0.35%

In addition, KIE has a P/E ratio of just 9.73. And the ETF also has a dividend yield of 2.03%.

Currently, this ETF has 41 holdings.

The top five holdings and percentage weight for KIE are –

Company Name Ticker % Weight
Genworth Financial GNW 3.02%
Assured Guaranty AGO 2.89%
Lincoln National LNC 2.82%
Protective Life PL 2.78%
Hartford Financial HIG 2.73%

Technicals:  The charts lead the way

After losing steam in early 2011, insurance stocks have been on the rise.  In fact, we’re looking at a clear uptrend here.

As you can see, the ETF has rallied well off of its 52-week low and is up over 39%.

However, there’s still plenty of room for KIE to climb before reaching a 52-week high of $45.75.


Adding to the bullish momentum, KIE is trading above its 50-day moving average.  And with this kind of momentum, it would take quite a bit to derail the rally.

In 2012, I expect we’ll see great profits from multi-line insurance companies and the insurance industry in general.

Trade Alert

Buy:  SPDR S&P Insurance ETF (KIE) up to $42.00
Recent Price:  $41.08
Price Target:  $50.00
Stop Loss:  $30.00

Remember:  KIE is poised to continue higher as the insurance industry improves profitability in 2012.  In addition, there are a number of multi-line insurance companies in the KIE such as Allstate, Progressive, and MetLife… just to name a few.  These multi-line carriers are forecast to outperform the rest of the industry.  Go ahead and buy KIE up to $42.00.


Consumer Discretionary (+4.4%)

Consumer spending seems to be stagnant at the moment.  According to the US Commerce Department, retail sales for January increased by just 0.4%.  That brings the annual increase to 5.8%.

However, retail stocks don’t seem to know there’s a slowdown…

Year-to-date, the consumer discretionary sector is up 9.17%.  That’s an impressive move to the upside.

While the stocks in the sector seem to be ignoring the economic data for now, eventually we should see a pullback in the sector.  We’ll keep an eye out for another opportunity to get back into this red-hot sector.

Consumer Staples (+2.3%)

Stocks in the Consumer Staples sector are taking on their traditional defensive role. Year-to-date, the sector ETF is up just 1.9%.

In fact, last week Forbes reported a $24.5 million outflow from the XLP.  That’s a 0.5% decrease in holdings.  While not a major sell off, it’s good to note.

The recent rally in the markets could be the reason behind such a move.  As defensive stocks stabilize, investors may be seeking out riskier assets for their portfolios.  As such, the XLP may sell off.

However, our PowerShares Dynamic Food & Beverage (PBJ) is showing nice gains. We’re up 3% right now.  Continue holding for steady gains.

Energy (+5.3%)

Energy stocks have put in a strong performance so far this year.  While energy prices rise, these stocks will be moving higher.

With a recent spike in oil prices over $105 per barrel, we may see this sector really heat up… and fast.  What’s more, with the conflict in the Middle East and Iran stopping delivery of oil to some EU nations… oil prices have nowhere to head but higher.

We’re closely watching this sector.  Let’s see how things shape up in Greece and the Middle East.

Financials (+6.3%)

Right now, financial stocks are one of the top performing sectors of 2012.  With a gain of nearly 11% in just six weeks of trading, we could be on the verge of a major rally.

Our iShares FTSE NAREIT Residential Plus Capped Index Fund (REZ) are back up to near recent highs… and good for a 18.3% gain right now.  Continue holding REZ for bigger gains ahead.

We’ve added the SPDR S&P Insurance ETF (KIE) in anticipation of even bigger gains in the financial sector.  More specifically, multi-line insurance carriers are poised to ramp up profits in 2012.  Buy KIE up to $42.00.

Healthcare (+1.1%)

Healthcare continues to be a volatile sector at the moment.  After seeing some big gains in pharmaceutical companies last month, the sector has cooled off a bit.

Just last week, the XLV saw roughly $60 million leave the fund.  That’s a decrease of 1.5%.

After selling at the recent top, we cashed in for an amazing 38.8% return on our biotech trade… FBT!  We’re going to stay away from this volatile sector for now.

Industrials (+3.6%)

We’re witnessing a bullish uptrend in industrials right now.  In fact, the XLI is just 3.5% from a three year high.

Most of the gains are due to a stream of positive US economic data.  As I pointed out in the trade alert earlier, we’re buying the XLI to take advantage of continuing growth of the US economy.

Buy the Industrials Select Sector SPDR ETF (XLI) to profit from this trend.  Buy XLI up to $38.25.

Technology (+7.3%)

The technology sector is another top sector for 2012.  Year-to-date the sector is higher by 10.5%.  In fact, the Technology Select Sector SPDR (XLK) just ticked over a five-year high last Friday.

And the reason is simple… earnings.

Technology earnings have had been very strong this quarter, with 67.7% of companies beating estimates.  According to Bespoke Investment Group, over two-thirds of companies that have reported are delivering a positive surprise.  That’s the second highest sector to beat earnings estimates… just behind consumer discretionary.

As a result, our SPDR S&P Semiconductor ETF (XSD) surged to a new high of $54.23 on Friday.  That’s an 18.8% gain for the year so far, giving us an overall gain of 13.7%.  Continue holding the XSD for a bigger return.

The iShares S&P NA Technology-Software Index Fund (IGV) also reached a new high on Friday, reaching $63.45 before closing at $62.68.  I expect we’ll continue to see the IGV climb throughout 2012.  Hold tight for more gains.

Materials (+1.8%)

The materials sector continues to remain range bound since our last update.

Gold, silver, and copper continue to trade in flux with events in Europe.  Gold trades higher when debt concerns flare up.  And it moves lower when investors are more at ease.

The materials sector appears as if it will remain fragmented.  There may be opportunity in the future, but for now we’re going to continue to avoid materials.

Utilities (+1.0%)

The utilities sector appears to be cooling off.  In fact, the Utilities Select Sector SPDR Fund (XLU) has underperformed the major market averages so far this year.  It’s down by 0.82% in 2012.

Based on the sector rotation model, we may be at the top in the utilities sector right now.  As such, I’m going to keep a very close eye on the XLU.  If it looks like a sell off will materialize, we’ll lock in the gains we have so far.  Continue to hold XLU.

Portfolio Changes

  • This month we’re buying XLI and KIE.
  • XHB, FBT, VGLT, and XLP were all closed in this month’s portfolio update.


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