SET Monthly Issue June 2010

| June 15, 2010

June 2010


Market turbulence over the last two months has shaken investor confidence.  It’s shaved more than 14% off of the S&P 500 from the high on April 26th to the low on May 25th.

We’ve also seen all nine sectors we track shed between 2.3% and 6.5% since the last issue of Sector ETF Trader.

And over the last three weeks, the S&P 500 has entered into a volatile trading range. It’s chopping around between support of the May 25th low and resistance of the 200-day moving average.

Take a look at the chart below to get a picture of the current situation.


The current technical setup indicates the S&P 500 will continue trading in this range in the short term.  And that’s likely what will happen unless we get some news to change investors’ outlook.

So the real question is… What news will be big enough to get stocks moving again?

Here’s my take on it…

EuroZone sovereign debt problems sparking the recent decline have been contained. It’s highly unlikely we’ll see this situation spiral out of control.  I think we’ve avoided a market collapse like 2008.

What we need now is confirmation the economic recovery can continue.  The most likely source to get investors interested in buying stocks again is jobs.

I’ll be watching the initial jobless claims, payroll numbers, and employment closely for signs of improvement.  Once the U.S. starts adding jobs, the strength and size of the U.S. economy should be able to carry a worldwide economic recovery forward.

Then the recent market correction will look like a great buying opportunity.  Let’s use this opportunity to pick up two ETFs with great potential at a discount.


Investing in biotech stocks isn’t for the faint of heart.

We’ve seen a crazy amount of volatility in this sector already this year.  We were able to grab a 25% gain in a matter of weeks when we recommended First Trust Biotechnology Index Fund (FBT) in January.

Since then, we’ve seen FBT give back the majority of those gains.  (Did someone say buying opportunity?)

The underlying investment thesis we gave back in January is still intact.  It’s only been temporarily derailed by the market correction.

The fundamental and technical indicators have aligned giving us another opportunity to profit from this action packed sector.

Macro/Economic Trend:  New Treatments and Fresh Capital

The biotech sector is a hotbed of merger and acquisition (M&A) activity over the last three decades.

Big Pharma companies are constantly building and re-building their pipeline of drugs. It’s a never ending battle.  They only have a window of a few years to profit before generic drug makers cut into sales and drive prices down.

Last year M&A activity focused on megamergers between many of the world’s largest drug makers.  As these integrations are completed, they’ll start looking to add new drugs to their pipelines via M&A activity.

We saw just how important the role of M&A activity can be earlier this year when we owned FBT. Two of FBT’s holdings were targeted to be acquired by larger firms.

Milipore (MIL) is being bought by the German conglomerate Merck KGAA.  And the Japanese drugmaker Astellas Pharma launched a hostile takeover of OSI Pharmaceuticals (OSIP).

The announcement of the deals sent MIL and OSIP stock prices soaring.  Both stocks were up nearly 50% after the news hit.  Deals like these make investing in biotech exciting and profitable.

I’m expecting more M&A deals and new drug development to send this sector rocketing higher.

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 rebalanced on a quarterly basis.  (We’ll see the percentage for each stock vary between rebalancing due to stock price movements.)

The equal dollar weighted index puts a bigger emphasis on small and medium sized companies than a market cap weighted index does.  And the smaller companies are where we’ll see the biggest gains!

The expense ratio is 0.8%.

The top five holdings and percentage weight for FBT are –

Company Name Ticker % Weight
Illumina ILMN 6.79%
Sequenom SQNM 6.43%
Millipore MIL 5.83%
Life Technologies LIFE 5.57%
Alexion Pharma ALXN 5.48%

Technicals:  The charts lead the way

IFBT hit its recent high of $38.32 on March 24th.  Over the next two and a half months, FBT fell 20% (primarily because InterMune’s (ITMN) lung cancer treatment failed to get FDA approval).

By June 8th, FBT hit a low $30.36.  This low corresponds nicely with its 200-day moving average.  You can see this on the chart below.


Since then, FBT has rebounded up to $32.33.  The support level of the 200-day moving average provides us with a low risk entry point to buy FBT.  As long as market sentiment doesn’t take a big turn for the worse, this level should provide support to FBT.

I’m expecting FBT to consolidate near this level before heading back to retest the highs it set back in March.

Trade Alert

Buy:  First Trust NYSE Arca Biotechnology Index Fund (FBT) up to up to $33.25
Recent Price:  $32.33
Price Target:  $40.00
Stop Loss:  $28.00

Remember:  Biotech stocks can be volatile.  But we have a solid floor of technical support from the 200-day moving average just below the current price.  FBT should consolidate near this level before M&A deals push the valuation of the entire industry higher.


The market correction has left no sector unscathed.  But some sectors have fared better than others.  The sectors holding up the best during the correction are typically the first ones to regain their momentum.

Large cap consumer service stocks are holding up remarkably well.  It looks like investors have already priced in all of the bad news.

This economically sensitive sector should lead the markets higher on any positive economic news.

Macro/Economic Trend:  Buying the Dip

U.S. retail sales were on a roll.  They had risen seven straight months going into the most recent retail sales report last Friday.

It’s no surprise the strong retail sales sent the consumer services sector up big.  TheiShares Dow Jones U.S. Consumer Services Sector Index Fund (IYC) was up more than 17% year-to-date before the market correction began in April.

Since hitting its high in April, IYC has given back most of its gains.

Then last Friday the May retail sales report was released.  Economists were expecting retail sales to increase by 0.2%. Instead, they fell by 1.2%.

Economists overshot the mark by 1.4%… You’d think that would mean trouble for consumer service stocks and IYC.

Well, think again… Consumer service stocks and IYC actually rallied and closed up for the day.  Investors didn’t even flinch at the bad news.  It tells me investors have already priced in stalling retail sales and slower growth rates.

Right now, investor expectations have fallen.  They’re at a point where bad news didn’t drive stock prices down further.

Any good news should trigger a rally.  It makes now a great time to buy IYC.

Fundamentals:  A closer look at IYC

IYC is a market cap weighted consumer services fund.  It holds 196 stocks in the retail, media, travel & leisure, and food & drug retail industries.

The expense ratio is 0.48%.

Right now the top five holdings and percentage weight for IYC are –

Company Name Ticker % Weight
Wal-Mart WMT 7.69%
McDonalds MCD 5.25%
Walt Disney DIS 4.32%
Home Depot HD 3.83%
CVS Caremark CVS 3.17%

Technicals:  The charts lead the way

The market correction has damaged the technical picture for most of the leading ETFs.  But IYC has managed to hold above the key support area of the 200-day moving average.

The 200-day moving average coincides with the support of the January high as well. Remember, when multiple indicators show support at the same level, it makes the support level stronger.

It’s a little difficult to see on the chart, but IYC’s bounced off of this support zone twice in intra-day trading in the past three weeks.  (The intra-day chart was unreadable because IYC traded at $154 during the flash crash.  So we’ll have to make do with this chart.)


The dual level of support just below the current price should provide us with a low risk entry point.

Trade Alert

Buy:  iShares Dow Jones U.S. Consumer Services Sector Index Fund (IYC) up to $61.00
Recent Price:  $59.22
Price Target:  $71.00
Stop Loss:  $52.50

Remember:  IYC is trading just above support of the January high and the 200-day moving average.  Investors’ expectations have come down considerably during the correction.  If the markets regain their momentum, IYC should lead the markets higher.


Consumer Discretionary (-2.3%)

Retail sales fell for the first time in seven months, but investors didn’t flinch.  Instead, they sent the sector higher on the day.  I think investors have priced in all of the bad news.  I’m expecting any good news to send the sector off to the races.  We’re recommending the iShares Dow Jones U.S. Consumer Services Sector Index Fund (IYC)… see page 8 for more details.

Our SPDR S&P Homebuilders ETF (XHB) has fallen out of favor with investors now that the home buyer tax credit has expired.  XHB could still make another run but we’ll need some positive news to get it started.  Hold tight for now.

Small cap stocks had been holding up better than the large caps until last week.  Then the entire small cap index broke down.  Our PowerShares S&P SmallCap Cons Disc Port (XLYS) hit our stop loss.  Go ahead and sell XLYS.

Consumer Staples (-2.9%)

So much for consumer staples being a defensive sector… it fell more than the more economically sensitive consumer discretionary sector this month!?!

Investor sentiment toward consumer staples is lackluster at best.  The only reason to own this sector is for their 3.1% dividend yield… or if you think the economy’s growth rate is going to flat line for the next decade.

Energy (-3.4%)

Oil’s trading in the mid $70s.  This is smack dab in the middle of the trading range.  The real news in the energy complex has been natural gas.  It’s shot up from around $4 to $5 in the last month.  Commodity traders are expecting a hot summer to spike the demand for natural gas over the next few months.

An even bigger problem for the industry is the oil spill in the Gulf of Mexico.  Although I am enjoying watching the ‘Big Oil’ CEOs get paraded through Congress like some sort of freak show… Are they the bearded woman or the goat boy?

Financials (-5.7%)

The financial reform bill is in the works.  Congress is in the final stages of ironing out the differences between the Senate and House versions.  The bottom line is the largest banks will be less profitable than before.  But on the plus side, they’ll also be less likely to implode and destroy our economy again.  It’s a tradeoff I can live with.
Bank profits shouldn’t drive the creation of wealth in America.  Banks should be there to fund the businesses creating wealth in America.  And banks can turn a small profit for their trouble.

If you’re a bank CEO and want to take more risk, turn bigger profits, and make more money… go run a hedge fund and leave the banking system alone.

Healthcare (-2.7%)

Healthcare costs are surging higher once again.  They’re expected to jump 9% by 2011.  You can bet employers will push off a portion of the increase onto employees.
The majority of healthcare stocks are so far off my radar they don’t even register.  At least until I understand how healthcare reform will impact the bottom line.  But I love the potential in the biotech industry.  I’m recommending the First Trust Biotech Fund(FBT) this month… see page 5 for more details.

Industrials (-6.5%)

After being slapped around for the last few months, industrials are starting to fight back.  Well, at least they’re showing they still have some fight in them.

We’ve gotten upbeat comments from a few industrial companies.  Strong demand is giving management reason to boost earnings guidance.  Investors now have hope the sector can continue growing.  Amazing, given the post apocalyptic world we live in where Greece can’t spend as much as it wants to keep the world economy going (thick sarcasm)… Seriously though, I’m expecting industrials to make a strong rebound.

Technology (-3.0%)

Tech stocks have lost their relative strength over the last few months.  Keep an eye on this sector for signs of life.  The bull market needs tech to be strong.

The way I see it, tech stocks look dirt cheap right now.  If you don’t own Rydex S&P Equal Technology ETF (RYT) or SPDR S&P SEMICONDUCTOR (XSD) already, go ahead and pick these two ETFs up now.

Materials (-2.9%)

Basic materials companies have staged a nice rally recently.  They’ve led the market higher over the last week.  If the Euro can regain some of the ground it’s lost to the U.S. Dollar, commodity prices and our Rydex Equal Weight Materials ETF (RTM) will be the prime beneficiaries.

Our Market Vectors Junior Gold Miners (GDXJ) needs gold to breakout to new highs. With the constant threat of uncertainty, it could happen at any time.

Utilities (-2.4%)

Utility stocks have bounced back over the last week.  And we’re still collecting our dividend on Utilities Select Sector SPDR Fund (XLU), which isn’t a bad thing considering the majority of ETFs we trade in Sector ETF Trader are down this month. It will be interesting to see how stocks react once dividends lose their favorable tax treatment at the end of the year. Hold tight for now.

Portfolio Changes

  • This month we’re buying FBT and IYC…
  • Sell PowerShares S&P SmallCap Consumer Discretionary (XLYS)…


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