SET Monthly Issue May 2011

| May 17, 2011

May 2011


“Sell in May and go away.”

This old Wall Street saying is a bit cliché.  But there’s no denying we often see a seasonal shift in market activity.  It’s uncanny how frequently stocks slump from May through October.

And this summer is shaping up to follow in the footsteps of a seasonal slowdown.

Here’s why…

The major catalysts for the market’s meteoric rise are coming to an end.  Namely, QE2 is ending and the US Dollar is strengthening.

Don’t forget, the weak US Dollar has played a big role in the booming commodity trade.  It’s fueled a strong bull market in stocks tied to commodities.

Now that QE2 is nearing an end, the US Dollar is showing signs of strength.  And the dollar’s on the verge of reversing a yearlong downtrend.

With the Fed taking its foot off the accelerator, it’s only natural for investors to take a step back.  These are unprecedented measures.  There’s just no way to know how the economy or the markets will react to the end of QE2.

Stocks have continued moving higher despite the obvious headwinds.  There’s no denying the bull market is still intact.

However, it’s important to note defensive sectors are now leading the market.  And cyclical growth sectors are lagging behind.  That’s a big shift in investor sentiment.

It’s a clear sign of a market running out of gas.  And it’s a trend I expect to continue throughout the summer.

Let’s grab two defensive healthcare ETFs with growth potential to maximize our profits.


I’ve said it before and I’ll say it again… Investing in biotech stocks isn’t for the faint of heart.

Over the past few years, we’ve nailed a couple of big runs in biotech ETFs.  In fact, on two different trades we captured gains of 23% and 25%.

Clearly, investing in biotech has huge upside.

The underlying investment thesis for biotech hasn’t changed.  Exciting new drugs and M&A activity are driving stock prices to new heights.

And now, thanks to a recent FDA ruling, the drugs biotechs create are more valuable than ever.

Macro/Economic Trend:  FDA Sets High Hurdle For Biosimilars

It’s no secret the biotech sector is a hotbed of merger and acquisition (M&A) activity. The reason’s simple…

Big Pharma companies are always on the lookout for new drugs to add to their pipeline.  It’s a never ending process.  They sell and profit from their brand name drugs until they lose patent protection.  Then generic drugs cut into sales and drive profits down.

At that point, they have to reload the pipeline with new drugs and the cycle repeats.

And biotech drugs are the fastest growing type of new drugs.  According to Medco CEO David Snow, “Biotech drugs will steadily swell from today’s 17% of total drug spending to 50% in 2020–just nine years.”

In other words, conditions are ripe for M&A activity.  And that means valuations of biotech stocks should move higher across the board.

And there’s more…

The industry gatekeeper, the FDA, recently outlined the process for bringing generic versions of complex biotech drugs (called biosimilars) to market.  This is the first time the FDA has outlined how to gain FDA approval for biosimilars.

And they set the bar high.

They’ve made the process as expensive and complex as possible.  The process for getting FDA approval of a biosimilar is exactly the same as for a newly developed drug. The FDA ruling limits generic competition and should allow biotechs to squeeze more profits from drugs they develop.

That’s great news for biotech drug makers.

And the new rules should spur even more acquisitions of biotech companies.

I’m expecting biotech stocks to continue moving higher as M&A deals send valuations soaring.  One ETF positioned to profit from this move is SPDR S&P Biotech ETF (XBI).

Fundamentals:  A closer look at XBI

XBI holds 45 biotech stocks.  The ETF tracks the S&P Biotechnology Select Industry Index.

The expense ratio is 0.35%.

The top five holdings and percentage weights for XBI are –

Company Name Ticker % Weight
Incyte INCY 3.95%
Ariad Pharmaceuticals ARIA 3.79%
Cubist Pharmaceuticals CBST 3.75%
Pharmasset VRUS 3.72%
Cephalon CEPH 3.67%

Technicals:  The charts lead the way

XBI rallied from $63.20 on March 29th to over $75 on April 29th.  It was an impressive 18% surge over the month.  It put XBI in a strong uptrend.

Since then, XBI has consolidated near the recent highs.  The good news is it’s held onto the gains and looks ready to move higher.  But it may need to spend a little more time building a new base before moving higher.

Take a look at the chart of XBI…


You can see it’s currently trading for $72.86.  Just above the 20-day moving average at $72.83.

The upward trending 20-day moving average stopped the pullback on May 5th.  And it should support XBI on this pullback as well.

Trade Alert

Buy:  SPDR S&P Biotech ETF (XBI) up to $75.00
Recent Price:  $72.86
Price Target:  $90.00
Stop Loss:  $65.00

Remember:  XBI is in a strong uptrend.  It should continue moving higher with the 20-day moving average acting as a support zone on any pullback.  Grab your shares now before biotech stocks take their next leg higher.


There’s been one constant in this two year old bull market.  Smaller stocks are outperforming large stocks across the board.

For example, the S&P 500 hit a bull market high of 1,370 a few weeks ago.  That’s an impressive 106% gain over the last two years.  And historically speaking, it’s an amazing return for large cap stocks.

But small cap stocks have done even better…

The Russell 2000 index of small cap stocks has soared from 342 to a recent high of 868.  That’s a jaw dropping 154% gain in a little over two years.

What’s more, I expect small cap stocks to continue outperforming large cap stocks going forward.  Let’s take a look at the small cap sector I expect to lead the way higher.

Macro/Economic Trend:  Sector Rotation

Last month I made it perfectly clear it was time for defensive stocks to shine.  And nothing I’ve seen lately has changed my mind.

Simply stated, the markets are facing serious headwinds.

We’re heading into the traditionally weak summer months.  The recent spike in energy prices indicates a possible peak in the business cycle.  And QE2 is finished at the end of June…

As a result, investors are moving money from risky sectors into defensive ones.

The good news is… I think investors will stay invested.

Remember, there are still positive economic developments the bulls can hang their hats on.  There’s no reason to become overly pessimistic at this point.

However, there’s no denying conditions are ripe for defensive sectors to lead.

I’m expecting investors to continue rotating money into defensive sectors for awhile. And small cap healthcare stocks should be a major recipient of the inflows.

As a group, small cap healthcare stocks look undervalued to me.  They’re certainly trading at more attractive valuations than small cap stocks in cyclical sectors like materials and energy.

And don’t forget, healthcare spending in the US exceeds $2 trillion per year.  An amount that’s only going to get bigger as baby boomers age.  But here’s the best part… The huge amount of money spent on healthcare creates an interesting dynamic.

Small cap healthcare stocks are not only a defensive investment, they have undervalued growth potential as well!

That’s an unbeatable combination in this uncertain market.  Let’s grab thePowerShares S&P SmallCap Healthcare Portfolio (PSCH) now to profit.

Fundamentals:  A closer look at PSCH

PSCH holds 71 SmallCap Healthcare stocks.  S&P SmallCap 600 Capped Health Care Index is made up of businesses providing healthcare-related products and services, including biotechnology, pharmaceuticals, medical technology and supplies, and facilities.

The expense ratio is 0.29%.

The top five holdings and percentage weights for PSCH are –

Company Name Ticker % Weight
Regeneron Pharma REGN 5.76%
HealthSpring HS 4.18%
Salix Pharmaceuticals SLXP 3.43%
American Medical Systems AMMD 3.38%

Technicals:  The charts lead the way

PSCH is in a strong uptrend… to say the least.

Since September, PSCH has gone from $22.31 to a recent high of $34.65.  That’s a massive 55% gain.

And PSCH is showing no signs of slowing.  It continues to reach new highs even as the broad market stumbles.  That’s clear cut evidence of sector leadership.


What’s more, the PSCH uptrend has followed the 20-day moving average closely.  Right now, PSCH is trading just above this technical support.  And it should continue moving higher in lock step with the 20-day moving average in the days and weeks ahead.

Trade Alert

Buy:  PowerShares S&P SmallCap Healthcare Portfolio (PSCH) up to $35.00
Recent Price:  $33.57
Price Target:  $40.00
Stop Loss:  $30.00

Remember:  PSCH is in a strong uptrend.  The recent pullback to support of the 20-day moving average is a good low risk entry point.  We should see healthcare stocks gain momentum as investors rotate money into defensive sectors.


Consumer Discretionary (+3.3%)

Retail sales are up again.  But something changed this month.  Retail sales growth was driven by higher food and energy costs not by an increase in the quantity of goods purchased.  It looks like higher food and energy costs are finally cutting into discretionary spending.

The good news is consumers aren’t letting higher prices get them down.  The recent Univ. of Michigan Consumer Sentiment index, a leading indicator of consumer spending, came in better than expected this month.

Consumer Staples (+4.1%)

Consumer staples had a great month.  The defensive sector is now a market leader. And the sector should continue leading as investors focus on reducing risk heading into the summer.

Our Consumer Staples Select Sector SPDR Fund (XLP) is off to a good start.  We hit a peak gain of 5% on Friday.  Continue holding for bigger gains.

Energy (-4.4%)

Energy stocks put in a double top earlier this month.  Since then, volatility has really picked up.

The price for a barrel of crude oil plummeted from nearly $115 to under $100.  The 17% correction seems to have taken some of the life out of the bull market.  Now investors are anticipating an even larger correction for oil prices.

The bottom line is oil prices were due for a correction.  And I don’t think this one is over yet.  Hopefully it makes for a good buying opportunity down the road.

Our alternative energy ETF, Market Vectors Global Alternative Energy (GEX) is under our buy up to price.  I still like the outlook for alt energy this year.  Go ahead and buy GEX up to $22 if you haven’t already.

Financials (-2.3%)

Financial stocks suffered their third losing month in a row.

Clearly, the housing market’s slow recovery is weighing on the sector.  And according to new data from, housing prices plunged 8.2% in the last year.

That’s a far cry from the improving housing market many analysts and bank executives were expecting.  I just don’t see how financial stocks will improve until the housing market stabilizes.

Our iShares FTSE NAREIT Residential Plus Capped Index Fund (REZ) is looking strong.  Demand for apartments continues to outpace new supply.  That’s a good sign residential REITs profitability will increase.  Continue holding REZ for bigger gains ahead.

Healthcare (+6.4%)

Healthcare stocks are leading the way.

Investors are rotating money out of cyclical sectors and into defensive sectors.  It’s a boon for healthcare stocks.  I’m recommending the SPDR S&P Biotech ETF (XBI) and the PowerShares S&P SmallCap Healthcare Portfolio (PSCH) this month.

Our iShares Dow Jones US Healthcare Providers (IHF) is off to a fast start.  IHF hit a peak gain of 11.3% on Friday!  That’s an impressive return in just our first month…

Industrials (+1.5%)

Industrials are up slightly.  The best performers in the sector are aerospace stocks. The airlines got a nice boost from falling oil prices.

What’s more, high grain prices should bode well for heavy equipment makers.  They should see sales accelerate as farmers rake in profits later this year.

But there’s trouble on the horizon…

One of the long leading indicators of industrial output shows a major slowdown will occur 12 months from today.  That’s not good news for anyone…

Our iShares Dow Jones U.S. Industrial Sector Index Fund (IYJ) hit a peak gain of 13% this month.  And the Market Vectors Agribusiness ETF (MOO) is hovering around our buy up to price.  Continue holding IYJ and MOO.

Technology (+2.8%)

Tech stocks can’t seem to shake their downtrend off the February highs.  Weakness has spread throughout the entire sector with electronic office equipment companies leading the way lower.

Investors are concerned the business upgrade cycle is nearing an end.  And they’re worried consumers’ wallets are being pinched by higher food and gas prices.  Both scenarios could lead to slower growth in the tech sector.

The good news is our iShares S&P North American Technology-Software Index Fund (IGV) hit our $65 price target on May 11th.  Congratulations to everyone locking in a 25% gain.

If you haven’t already, buy PowerShares S&P SmallCap Technology Portfolio(PSCT) up to $33.

Materials (-0.8%)

Materials stocks are down again this month…

It was an extremely volatile month for precious metals.  The silver bubble burst with a magnificent explosion.  The iShares Silver Trust (SLV) lost 33% in less than two weeks.  And commodity prices haven’t regained their bullish momentum since.

The selloff in precious metals hasn’t been kind to our mining stocks.  Market Vectors Gold Miners ETF (GDX) and First Trust ISE Global Platinum Index Fund (PLTM) have given back their gains.  But they could rebound just as quickly.  Continue holding PLTM and GDX for a rebound.

Utilities (+5.6%)

Utilities broke out of their funk this month.  But utilities are still my least favorite defensive sector.  They’re exposed to inflation and any economic slowdown.  We’ll keep utility stocks on the back burner for now.

Portfolio Changes

  • This month we’re buying XBI and PSCH.
  • Sell iShares S&P North American Technology (IGV) for gains of 25% or more.


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