SET Monthly Issue May 2010

| May 18, 2010

May 2010


There’s been quite a bit of excitement in the financial markets lately.  It’s the kind of excitement I can live without.

A sovereign debt crisis in Europe… A mini-crash in U.S. markets… A massive oil spill… And financial reform… just to name a few.

It’s all anybody in the financial media can talk about.  But most of these issues were already present during the recent rally.

Did something happen?  What suddenly caused bad news to overshadow great economic data from the U.S right now?

I know it’s easy to forget… but there is good economic data coming in by the truckload.  Just look at the leading indicators.  They’ve been positive for some time… and are still improving.

Now lagging indicators like job growth are turning positive.

Private company payrolls surged by 231,000 in April.  And they also revised March numbers higher.  This is great news…

Economic data’s getting stronger and the problems are basically the same.  Could increased media coverage and fear really cause all this chaos?

I think the answer is much simpler.

Take a look at this weekly chart of the S&P 500.


The dashed line is the 200-week moving average.  A 200-period moving average is the brick wall of moving averages.  The longer the time frame, the tougher it is.

It’s an ideal place for bears to make a stand.  And did they ever make a stand…

Many computer programs, institutional players, and individual investors alike placed their bearish bets when the S&P 500 hit the 200-week moving average.

It was the perfect storm…

Prior to the correction, the markets had been lazily drifting higher on low volume.  In other words, the rally lacked conviction.

Then the bears came in heavy with their short bets… It sent the computers haywire. It triggered a massive selloff that sent the Dow down 1,000 points in a matter of minutes.

The bottom line is the European debt crisis didn’t cause the one day decline.  In my opinion, it was traders placing bearish bets based on technical analysis that triggered the fall.

But the debt crisis, the mini-crash, and talks of financial regulation have all played a roll.  They’ve undermined investor confidence.  It’s brought fear back into the markets.

Remember, the long term dominant trend is up.  The economic data says the economy’s getting stronger.  When fear gives way to greed (as it always does), this correction will look like a great buying opportunity.


Real Estate Investment Trusts or REITs are a wonderful creation.

A REIT is a corporation that invests in real estate.  As long as the REIT passes along 90% of their profit to investors, it doesn’t have to pay corporate income taxes.  This is a huge tax advantage.

REITs can invest directly in real estate or they can invest in mortgages.  Those that invest directly in real estate can own office, industrial, retail, and residential properties.

Some REITs are very specialized, focusing solely on one type of real estate or mortgages.  Others own many different types of properties and mortgages.

But they all share a few things in common…

Macro/Economic Trend:  From bad times to good

The REIT industry was hit hard by the economic slowdown.

REITs typically use a lot of borrowed money.  They use leverage to juice up their returns.

When the credit crisis hit and the real estate market fell apart, many REIT weren’t prepared to deal with the collapse.  It’s a drawback to being heavily leveraged.  Some REITs couldn’t weather the economic downturn and were forced into bankruptcy.

It wasn’t a good time to own REITs.  But that was then (2007 & 2008) and this is now…

The collapse also created a great opportunity for the bigger and better positioned REITs.  They were able to cherry pick the best properties and buy them for a song.

The large REITs are also benefiting from the credit crisis…

Right now, community and regional banks are sitting on a pile of bad commercial real estate loans.  They’re in no hurry to lend money to build more commercial properties. And they’re the ones who typically fund most of the commercial real estate development.

This should keep new supply off the markets and competition for tenants low.

It’s good old supply and demand.  A small uptick in demand as the economy recovers should drive rents and profitability up.

As profitability increases, it should drive REIT stock prices higher as well.

Investors have taken notice of the strong fundamentals and sent REITs up sharply this year.  But the recent pullback has created a great buying opportunity.

The ETF I like to profit from the surge in REIT profitability is iShares Dow Jones U.S. Real Estate Index Fund (IYR).

Fundamentals:  A closer look at IYR

IYR is market cap weighted.  It owns stock in 76 REITs.  The majority of the holdings invest in industrial, office, retail, and residential properties.

The expense ratio is 0.48%.

The top five holdings and percentage weight for IYR are –

Company Name Ticker % Weight
Simon Property Group SPG 8.62%
Vornado Realty Trust VNO 5.00%
Equity Residential EQR 4.36%
Public Storage PSA 4.21%
Boston Properties BXP 3.78%

Technicals:  The charts lead the way

IYR is one of the best performing ETF so far this year.  It’s up 10%, while the S&P 500 is just above breakeven.

And it’s held onto its gains better than other sectors the last few weeks.  It’s one sector that’s showing relative strength.

It briefly undercut support of the 50-day moving average last week.  But it’s back above this crucial support level.  And just as importantly, it never violated the support line of the uptrend.

Take a look at the chart.  You’ll see the strong uptrend…


The uptrend has consistently set higher highs and higher lows over the last year.  Yet, IYR hasn’t recovered even 50% of the losses from its peak in 2007.  So it still has plenty of upside potential.

Trade Alert

Buy:  iShares Dow Jones U.S. Real Estate Index Fund (IYR) up to up to $52.75
Recent Price:  $51.37
Price Target:  $65.00
Stop Loss:  $45.00

Remember:  Fear is dominating the markets.  Eventually fear will give way to greed. But it’s hard to pinpoint the exact moment it will happen.  So we could see some volatility in the very near term.  But right now we have a great setup with solid fundamentals.  Let’s grab shares of IYR now before its momentum really heats back up.


It’s pretty easy to hate “Big Oil” right now.  Just look at the mess we have down in the Gulf of Mexico.

An oil rig named Deepwater Horizon operated by BP (BP) is spewing thousands of barrels of oil into the water on a daily basis.  Environmental disasters like this breed hatred of offshore drilling and oil companies.

But environmental disasters aside, we still need oil… It’s a fact that isn’t changing in the short run.

And Big Oil will be there to rake in the profits…

Macro/Economic Trend:  Is the dollar rally running out of steam?

This trade is more about a great technical setup than an economic trend.  But there’s usually a little bit of both driving every sector move.

So far this month, oil prices have taken it on the chin.

This is one area really being hurt by the European crisis.  More specifically, it’s the crisis in the Euro, the European currency.  The Euro is losing value relative to the U.S. Dollar.  Since May 1, the Euro is down more than 8%.

As the U.S. Dollar goes up in value, commodities traded in U.S. Dollars become more expensive in other currencies.  It’s putting pressure on oil prices.

Since May 1st, the price for a barrel of oil has fallen from over $87 to under $72. That’s a drop of more than 17% in just a few weeks.  But if you’re buying oil using the Euro, the price you pay is only down a fraction of that.

I think this a great price to get bullish on oil.

The drop in oil prices has sent shares of the Energy Select Sector SPDR (XLE) down more than 12%.

If the U.S. Dollar falls back from it 52-week high or investors’ fears subside, oil prices could see a big rally.  And even if they don’t, Big Oil is still very profitable with $70 a barrel oil.

Fundamentals:  A closer look at XLE

XLE is a market cap weighted oil and gas index fund.  It holds 39 stocks in the oil and gas industry.  It’s dominated by a few large cap stocks.  The top five holdings make up almost half of the ETF.  And maybe more importantly, XLE doesn’t hold BP

The expense ratio is 0.21%.

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

Company Name Ticker % Weight
Exxon Mobil XOM 17.43%
Chevron CVX 13.78%
Schlumberger SLB 6.93%
ConocoPhillips COP 5.24%
Occidental OXY 4.94%

Technicals:  The charts lead the way

Take a look at the chart of XLE.  You’ll see it’s in a clearly defined upward sloping trading range.


And more importantly, it’s near the bottom of the trading range.  It’s just above the support line.

It’s tested this support level three times in past few months.  It’s held each time. Clearly there are a lot buyers stepping in when XLE reaches this level.

We could see XLE trade back up to the high end of its trading range relatively quickly. That should be good enough for a quick 12% gain.

Trade Alert

Buy:  Energy Select Sector SPDR (XLE) up to $57
Recent Price:  $55.66
Price Target:  $62.50
Stop Loss:  $52.50

Remember:  XLE is being driven by a mix of technical and fundamental data.  But the overriding trend for XLE is trading in an upward sloping range.  Buying XLE near the support line of the range should help limit any downside.  And it allows us to grab a quick profit as it moves back toward the resistance line of the trading range.


Consumer Discretionary (-4.0%)

Another month of strong retail sales gains in April added to a very good March.  And an improving employment picture bodes well for the sectors continued run.  Even after pulling back, the sector remains in a strong uptrend.  And it’s a similar story for our two ETF in this sector.

Our SPDR S&P Homebuilders ETF (XHB) hit a peak gain of nearly 30% before the correction.  And our PowerShares S&P SmallCap Cons Disc Port (XLYS) has held up well throughout the correction.  Hold tight for a rebound in both these ETFs.

Consumer Staples (-2.3%)

Investor sentiment toward consumer staples is lack-luster at best.  Even throughout the market correction, investors opted to stick with cyclical stocks or get out of stocks all together.

The defensive sector has already recovered the majority of its ’08 losses.  I don’t see them making a big move anytime soon.

Energy (-5.2%)

Oil continues to trade in a range.  And the big oil and gas companies mirror the rise and fall in oil prices.  Right now oil is back near the bottom of the range.  We’re recommending the Energy Select Sector SPDR (XLE) to profit from a bounce back to the high of the trading range.  See page 8 for more details…

Financials (-6.0%)

The rally in financials stocks came unglued this month.  First, Goldman Sachs (GS) came under fire from the SEC for their role in a mortgage backed security deal.  It’s never a good sign when terms like fraud start to get tossed around… Then the mini-crash in U.S. stocks stirred up investor fears to levels not seen since early 2009.  Now the debate on tougher financial regulations is picking up steam in Washington.  It’s enough to make me leery of taking the plunge into financials.

Healthcare (-5.2%)

Healthcare reform is a done deal.  But gauging the impact on the sectors profitability is an entirely different matter.  So far investors are hesitant to put money into a sector under the control of government.  And I can’t blame them.  Until we know how the new rules will impact the bottom line, I’m steering clear.

Industrials (-2.8%)

Economic expansion is well underway.  And I think it’s just getting warmed up.  The average length of previous economic expansions is about five years.  So by that measure, we’re still in the early stages.  Industrials should continue to grow revenue and earnings as the expansion picks up steam.  Our Dow Jones Transportation Index Fund (IYT) hit a peak gain of 16%.  And the uptrend is holding strong.

Technology (-5.6%)

Tech stocks have been extremely volatile recently.  There have been rumors floating around the earning cycle may already have peaked last quarter.  I don’t buy it. There’s too much pent up business demand.  As businesses spend money to upgrade outdated technology, they’ll continue to push revenue and earnings higher.

Our Rydex S&P Equal Technology ETF (RYT) and SPDR S&P SEMICONDUCTOR(XSD) have seen their share of volatility.  But I think tech stocks will regain their momentum as investors’ fears fade.  Hold onto these picks.

Materials (-8.0%)

The basic materials industry was in an uptrend until this month.  The sell off was led by the largest companies.  Our Rydex S&P Equal Weight Materials ETF (RTM) outperformed the market cap weighted materials ETFs.

Our Market Vectors Junior Gold Miners (GDXJ) hit a new peak gain of 18% as gold prices soared to record highs.  As long as fear and uncertainty remain in the market, gold can still move higher from here.

On the flip side, Market Vectors Agribusiness ETF (MOO) was weighed down by it biggest holding, Monsanto (MON).  It closed below our stop loss on May 6th. Everyone should have sold MOO at market the following day.

Utilities (+0.3%)

Utility stocks were the best performing sector this month.  They managed a 0.3% gain… I’ve been really disappointed in Utilities Select Sector SPDR Fund (XLU) performance.  But it’s trending higher since February and held up better than any other sector this month.  Hold tight for now.

Portfolio Changes

  • This month we’re buying IYR and XLE…
  • Sell Market Vectors Agribusiness ETF (MOO)…

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