SET Monthly Issue July 2013

| July 16, 2013

July 2013


Interest rates are soaring in the wake of Fed Chairman Bernanke’s ‘tapering’ talk.

In fact, the yield on the benchmark ten-year Treasury is at the highest level in nearly two years.

As I pointed out last month, if the Fed wanted to keep long term interest rates low, they needed to backtrack on the possibility of an early exit from QE.

But they didn’t… and predictably long term interest rates have begun to rise rapidly.

As I’m sure you know, there was a lot of big money that had thrown their weight behind the QE forever trade.  It was easy money…

This crowded trade unwound quickly as traders adjusted their strategy to the fact that QE wouldn’t go on forever.

Here’s the thing…

The US economy is still a long way off from the Fed’s stated targets for inflation and unemployment.

Right now the Fed’s favorite inflation gauge – core personal consumption expenditures index – is at 1.3%.  That’s well below the 2.5% target.

And an unemployment rate of 7.6% is still well above the Fed’s 6.5% target.

In short, the US economy needs to improve before the Fed makes any more changes.

At this point, the Fed’s course over the next several months has been laid out and communicated to investors.  So, I’m expecting the Fed to play less of a role in stock market performance.

If the economy continues to improve – as expected – it should bode well for the cyclical ETFs in our portfolio.  They typically outperform when economic growth is on the upswing.

And rising interest rates should provide a lift to this month’s recommendation…


Community banks are a different animal than megabanks like JP Morgan (JPM), Bank of America (BAC), and Wells Fargo (WFC).

Typically, community banks are solely focused on traditional banking activities of collecting deposits and making loans.  While their larger brethren offer a much wider array of financial services.

The result is two vastly different businesses with very different risk profiles.  Needless to say, if a small community bank fails, it doesn’t have nearly the impact on the economy as if JP Morgan goes belly up.

However, these differences seemed to be lost on financial system regulators.  In many cases, the new banking regulations treated small community bankers and ‘too big to fail’ banks the same.

But a new rule recently issued by the Fed significantly eases the burden of capital reserve requirements on community banks.  What’s more, it all but eliminates the regulatory burdens that threatened to crush the industry.

Obviously, that’s great news for community banks.  And it’s the reason we’re recommending First Trust NASDAQ ABA Community Bank Index Fund (QABA).

Macro/Economic Trend:  Net Interest Margin

There’s no doubt about it, community banks dodged what would have been a big blow to the industry.  But that’s not the only thing that’s kept community banking profits depressed lately.

Banks with less than $1billion in assets are struggling with skinny net interest margins.
The net interest margin, or NIM, is simply the difference between the interest income generated on loans they have made and the amount of interest they paid out on deposits, relative to the amount of assets.

In short, NIM is the gross margin.

As you can see in the FRED chart below, NIMs have been steadily declining for years.


You can also see NIMs rebounded after hitting a low of around 3.7% in 2009.  But NIMs have slumped back to their lowest levels on record as QE3 drove long term interest rates down.

I’m expecting to see NIMs expand quickly from the recent lows.  I think we’ll see NIMs settle into a range between 4.0% and 4.4% over the next few years.

In short, there hasn’t been a better time to invest in community banks in the last 30 years.

Fundamentals:  A closer look at QABA

QABA tracks an index of market capitalization-weighted common stocks of all NASDAQ listed banks and thrifts or their holding companies that are designated as banks by the Industry Classification Benchmark.

It also excludes the 50 largest banks based on asset size and any bank specializing in international banking or credit cards.

In order to be included, the stock must have a market-cap of at least $200 million and a three-month average daily dollar trading volume of at least $500k.

The gross expense ratio is 1.04%.  But they’re capped at 0.60% until April 30, 2014. And the annual dividend yield is 2.21%.

The top five holdings and percentage weight for QABA are –

Company Name Ticker % Weight
Zions Bancorporation ZION 4.26%
BOK Financial Corp BOKF 3.50%
Signature Bank SBNY 3.22%
Commerce Bancshares CBSH 3.20%
East West Bancorp EWBC 3.00%

Technicals:  The charts lead the way

So far this year, QABA has risen 10% over the last month.  That makes it one of the best performing ETFS over the last four weeks.

It recently reached a 52-week high of $32.60.  And it has consolidated those gains in a bullish flag continuation pattern.


Obviously, that type of performance is bound to get investors attention.  And over the last few weeks, we’ve seen strong inflows on the percentage basis into QABA.

I’m expecting QABA to breakout and above the recent high and continue moving higher in short order.

Trade Alert

Buy:  First Trust NASDAQ ABA Community Bank Index Fund (QABA) up to $32.75
Recent Price:  $32.00
Price Target:  $$40.00
Stop Loss:  $28.50

Remember:  QABA possesses a combination of strong fundamentals and a bullish technical setup.  Grab your shares below $32.75.  I’m expecting bullish momentum to carry this ETF up to around $40.00 per share.  That’s good enough for a 25% gain.


Consumer Discretionary (+5.7%)

Consumer discretionary stocks rebounded with a 5.7% increase after dipping 1.8% last month.  But the latest report on June retail sales shows sales were weaker than expected.  In fact, retail sales didn’t grow at all when you exclude auto and gasoline sales.  That doesn’t bode well for 2nd quarter GDP.

Our iShares US Home Construction ETF (ITB) has been volatile as investors weighed the impact of higher mortgage rates on new home construction.  We likely won’t see much change until June new home sales are reported next week.  Continue holding for bigger gains ahead…

Consumer Staples (+1.9%)

Consumer staples bounced back to this month.  They erased almost all of the 2% loss from the previous month.  But staples have clearly lost their leadership role in this market.  At this point, this sector is still a little too pricey for my taste.

Energy (+2.4%)

A decrease in stock piles of crude oil and gasoline has sent the price of WTIC crude oil soaring to nearly $107 per barrel.  Data from the American Petroleum Institute showed U.S. crude oil inventories fell by 2.6 million barrels last week, while stockpiles at Cushing, Oklahoma declined by 880,000 barrels.

At this point, I think it’s time to ring the cash register on SPDR S&P Oil & Gas Equipment & Services ETF (XES).  I’m concerned shrinking margins for oil services could lead to some weaker than expected earnings across the industry.  Sell XES now for a 12% gain.

Morgan Stanly Cushing MLP High Income Index ETN (MLPY) recently paid a juicy 34 cent dividend.  Our total return on MLPY is now approaching 7%.  That’s not too shabby… continue holding for bigger gains.

Financials (+4.6%)

Financials 4.6% gain last month made it one of the top performing sectors.  The surge in bank stocks sent our SPDR S&P Bank ETF (KBE) through our $29 price target.  We cashed in for a total gain on investment of 23.8%.

But this isn’t the end of the run for financial stocks… In fact, we think community bank stocks are on the verge of a major run.  We’re recommending First Trust NASDAQ ABA Community Bank Index Fund (QABA)… see Trade Alert for more details.

Healthcare (+2.9%)

Healthcare stocks are looking good heading into earnings season.  The solid mix of large cap healthcare companies in our Health Care Select Sector SPDR (XLV) should drive it to a new 52-week high in short order.  Continue holding…

Industrials (+3.0%)

Industrial production and capacity utilization increased in June.  But the rate continues to slow… and we still haven’t reached the 2007 levels.  But investors remain optimistic the economic growth in the US will accelerate in the second half of the year.  That bodes well for our iShares Dow Jones US Industrial ETF (IYJ)… continue holding.

Technology (+2.0%)

Tech stocks have been on a roll lately.  And for good reason… tech stocks have a strong history of performing well when interest rates go up.  And we all know how much interest rates have shot up recently!

Our latest recommendation, Guggenheim S&P 500 Equal Weight ETF (RYT), is up more than 5% this month.  As expected, as soon as it broke out to a new 52-week high, the bullish momentum really started to fuel some nice gains.  Continue holding…

Our iShares Semiconductor ETF (SOXX) just hit a new high of $66.63.  That’s good enough for a 15% gain.  What’s more, SOXX has made those gains in the face of pessimistic smartphone and PC sales growth estimates.  Continue holding…

The First Trust Internet Index Fund (FDN) is another one of our ETFs that’s been on fire lately.  FDN hit a recent high of $49.14… that’s an impressive 27.9% gain.  Keep an eye on FDN as it approached our $51.00 price target.

Materials (+0.2%)

Materials stocks continue to struggle against the weak global economic outlook.  And that’s not likely to change unless we see China or Europe or any place that’s not the US to show some signs of economic acceleration.

However, we have seen some commodity prices rebound from their recent lows.  The recent drop in lumber prices has stabilized and could be on the verge of a bullish reversal.  In fact, our Guggenheim Timber ETF (CUT) is back within 2% of the 52-week high.  Continue holding CUT for bigger gains.

Utilities (+3.3%)

Utilities stocks have been unusually volatile of late.  This is direct result of the dislocation of interest rates in the wake of the Fed tapering comments.  What’s more, the sector faces headwinds from flat US electricity demand, stagnant power prices, and higher capital spending requirements.

Portfolio Changes

  • This month we’re buying QABA.
  • Sell XES for a gain of 12.1%.

Category: SET Monthly Issues

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