SET Monthly Issue May 2014

| May 20, 2014

May 2014


Former Chairman of the Federal Reserve, Ben Bernanke, has been making waves in the financial industry over the last few weeks.

He’s been hosting private dinners with Wall Street elite.  It costs $250,000 to get a chair at one of these events.  So, I haven’t been myself.  But the details of these meetings have been leaked.

His candid forecast for future Fed action has had an impact on financial markets.

In short, Mr. Bernanke doesn’t think he’ll see the short-term Fed funds rate back above the long-term average of 4% during his lifetime.

That prediction flies in the face of most market prognosticators that expect to see interest rates back near this level within the next few years.

As a result, we’ve seen interest rates on US Treasuries drop to their lowest levels in months.

What’s more, the yield on the 10-year US Treasury has gotten cheap relative to other countries.  The government debt of countries like France, Germany, Japan, and many others are all more expensive than the US.

And the expectation is the European Central Bank will drive interest rates even lower in an attempt to spark economic growth.

This creates an opportunity for big investors to profit from the difference in yields between US and other countries. And the net effect is US interest rates come down.

Clearly the idea that ‘interest rates can only go up from here’ is flawed.  As other countries drive their interest rates down, it makes US Treasuries cheap in comparison.

Here’s the thing…

The low interest rate environment that’s likely to persist for a long time is extremely supportive of economic growth.  It creates a very good situation where inflation is tame and economic growth is steady.

And I’ve got an ETF for you that should reap the rewards of exactly this type of environment…


Momentum and growth stocks, and the ETFs that hold them, dominated the list of top performers over the last few years.  At the same time, many cyclical sectors have underperformed relative to these high flying names.

One industry that has been stuck in a downcycle while the S&P 500 has shot up 50% over the last three years is metals and mining.

In fact, the performance of ETFs that hold companies involved in the extraction and production of metals and minerals has been awful over the last three years.  The two metals and mining ETFs that have been around at least three years have lost 39% and 55% of their value during that time.

But there are signs the period of underperformance for metals and mining stocks and ETFs is coming to an end.

Macro/Economic Trend:  India and Low Costs

After the credit crisis and Great Recession is 2008 and 2009, metals and mining stocks enjoyed a period of growth that lasted from 2010 until early 2012.

The growth was largely fueled by China’s and other emerging markets’ accelerating economies.  Their insatiable demand for raw materials pushed commodity prices up and the metals and mining companies reacted by increasing production.

As economic growth cooled off in many emerging markets, the demand for raw materials has cooled off.  And many metals and mining companies found themselves with much lower cash flow and expensive mining equipment that they no longer had a use for and couldn’t afford.

Over the last few years, metals and mining companies have undergone a painful but needed reduction in costs and capital expenditures.  Now the industry is lean and mean. And it’s ready for the next wave of economic growth to spark demand.

In order for that to happen, economic growth in emerging markets needs to accelerate. And it appears the conditions are right for that to happen.

One of the biggest things holding back emerging markets has been the uncertainty surrounding interest rates.

The expectation of higher rates in the US means less capital available to emerging markets and even higher rates in those emerging markets.  This has hurt growth, sparked inflation, and caused all sorts of havoc with foreign currencies.

Now investors are coming to terms with reality…

As I pointed out earlier, interest rates in the US are unlikely to climb as high as expected as quickly as expected.  And it’s calming investor fears about higher interest rates hurting growth in emerging markets.

What’s more, the recent election of Mr. Modi and his Bharatiya Janata Party in India could awaken the sleeping giant of emerging markets.

This will be the first time a single-party majority has existed in India since 1984.  And it paves the way for new pro-growth and pro-business policies to be enacted quickly.

The development of India’s infrastructure alone could spark demand for raw materials that dwarfs the consumption of China in short order.

The bottom line is the conditions are ripe for metals and mining stocks to reverse the downcycle.  The ETF I like to profit from the rebound is the iShares MSCI Global Metals & Mining Producers (PICK).

Fundamentals:  A closer look at PICK

PICK tracks an index of 246 US and foreign stocks involved in the global metals and mining.  It doesn’t include any gold and silver miners.

The expense ratio is 0.39%.  And it has a dividend yield of 3.46%.

The top five holdings and percentage weight for PICK are –

Company Name Ticker % Weight
BHP Billiton (AUS) BHP 12.81%
Rio Tinto RIO 7.86%
BHP Billiton (UK) BLT 7.75%
Glencore Xstrata GLEN 6.50%
Anglo American AAL 4.10%

Technicals:  The charts lead the way

PICK is currently trading for $19.68.  It’s basically breakeven on the year.  It’s 3.9% below the 52-week high and 26% above the 52-week low.


As you can see, PICK reversed the downtrend in July of 2013 and established a new uptrend.  Over the last seven months, it has carved out a nice rounded base.  I’ve drawn the red line so you can see the rounded bottom or cup that has formed.

This looks to be the final stages of a cup with handle continuation pattern.  After trading back near the 2013 highs, PICK is now forming the handle.  The pattern will be complete when PICK breaks out and makes a new high.

This is a nearly perfect cup with handle setup.  It established an uptrend, the cup is a perfect ‘U’ shape, the depth of the cup is 50% of the previous advance, the handle is forming, and the 7-month duration is spot on.

The projected advance after the breakout is about $2.50 per share.

Trade Alert

Buy:  iShares MSCI Global Metals & Mining Producers (PICK) up to $20.50
Recent Price:  $19.68
Price Target:  $26.00
Stop Loss:  $18.00

Remember:  PICK has formed a cup with handle continuation pattern that bodes well for a quick jump up to around $23.00 per share.  From there, the improving fundamental story for the metals and mining industry should push shares of PICK toward our $26.00 price target.


Consumer Discretionary (+2.1%)

Consumer discretionary stocks rebounded with a 2.1% gain over the last month after a 5.4% drop over the previous one month period.

Retail sales growth for March was revised higher by 0.4% to 1.5%.  That’s the largest monthly jump in more than four years.  However, the shopping spree in March seems to have put a damper on April sales as they slumped to a meager 0.1% gain and came up short of expectations.

The combination of weak April sales combined with investors rotating money out of growth stocks and into cyclical stocks has zapped the bullish momentum out of the sector so far in 2014.

iShares US Home Construction ETF (ITB) has largely ignored the upbeat consumer sentiment, job growth, and falling interest rates.  ITB has given back all of the gains it had racked up over the first quarter.  It’s now back to the 200-day moving average. What’s more, builder sentiment has fallen off in recent months as the recovery in new home sales hasn’t materialized.  Sales have fallen off as home builders have raised prices.  After an unusually cold winter, we should see the pace of construction accelerate over the next few months.  Continue holding.

PowerShares Dynamic Media Portfolio (PBS) has been hit hard by the rotation of consumer growth stocks in 2014.  This ETF is now down 11.5% year-to-date.  Not even the proposed buyout of DirecTV (DTV) by AT&T (T) could get investors excited about this industry.  AT&T is reportedly offering $100 per share for DTV that currently trades at $83 per share.  The lack of movement in DTV share price indicates investors don’t think AT&T will be given regulatory approval for this acquisition.  I believe the correction has been overdone.  We’re seeing investors start to pick up former hot growth stocks at big discount to where they were trading a few months ago.  If this trend continues, we should see PBS rebound in short order.  Continue holding.

PowerShares Dynamic Leisure & Entertainment Portfolio (PEJ) is another ETF that has been bitten by the weak retail sales report and the investor rotation out of growth stocks.  The correction in PEJ’s share price has sent this stock back to our original buy price.  I’m expecting retails sales to rebound in May after a disappointing April.  Continue holding.

Consumer Staples (+2.6%)

Consumer staples outperformed consumer cyclical stocks for the third month in a row. This is a sign that the rotation out of growth in favor of value and safety hasn’t reached an end.  In fact, the consumer staples ETF (XLP) set a new all-time high of $44.70 per share last week.

Our First Trust Consumer Staples AlphaDEX Fund (FXG) is also making new highs. The recent high of $38.24 is 10% above where we recommended buying it six months ago.  Continue holding.

Energy (+4.5%)

Energy stocks once again led all sectors last month with a 4.5% gain.  The rotation into undervalued stocks continues to benefit energy stocks that haven’t seen valuations soar to the extent as growth stocks.  What’s more, the relative stability of oil prices that are hovering around $100 per barrel are bolstering investor confidence.

Our Market Vectors Unconventional Oil & Gas ETF (FRAK) has been up as much as 5% since we recommended it last month.  It’s still below our $32.00 buy up to price. Grab your shares of FRAK up to this level if you haven’t already.

On the other hand, our Guggenheim Solar ETF (TAN) continues to sell off.  There’s no easy way to say it… this selloff hurts.  All of the big names that led the rally have taken a dive.  This is clearly a sentiment driven rally and solar stocks are out of favor with investors.  The silver lining is we bought this ETF at a great time… we’re still up 10% on this trade.  What’s more, I still believe in the fundamental story of solar. Continue holding.

Our Morgan Stanley Cushing MLP Hi Income ETN (MLPY) has seen an uptick in share price as the forecast for rising interest rates has weakened.  Lower interest rates makes the dividend yield on MLPY that much more valuable.  Feel free to buy MLPY up to $18.50 if you don’t already own it.

Financials (+1.9%)

Financials have slumped in recent weeks. But the sector still managed a 1.9% gain over the last month.  This sector has been hurt by some of the largest hedge funds reportedly reducing their exposure to the financial industry.  It’s not surprising given what they learned from Ben Bernanke in their expensive sit-downs over the last few weeks.

The Financial Select Sector SPDR Fund (XLF) is now 4% below its 52-week high. It’s currently trading for $21.86… slightly above our initial buy price.  The sector is clearly weighing on the S&P 500.  But at this point, a larger correction doesn’t seem likely.  In fact, it could be setting up for a period of outperformance in the weeks ahead.  Grab your shares up to $22.25.

Our First Trust NASDAQ ABA Community Bank Index Fund (QABA) has taken it on the chin as the expectations for rising interest rates have faded in the last week.  If interest rates don’t rise, it will be difficult for community banks to expand net interest margins.  At this point, the catalyst we were looking for just hasn’t played out.  And it could get worse as more people jump on the bandwagon with Bernanke’s prediction of low rates for a very long time.  Let’s sell QABA now for a 6% profit and look for better opportunities.

Healthcare (+4.4%)

Healthcare stocks rebounded with a 4.4% gain over the last month after suffering a 5.1% drop over the prior month.  It’s a bit unusual for this sector to experience so much volatility.  The majority of the volatility has been driven by growth stocks in biotech industry.

Industrials (+4.1%)

Industrials recorded a strong 4.1% increase over the last month.  The sector is in a strong uptrend and just hit a new 52-week high last week.  But this sector needs economic growth to accelerate in order to see cyclical growth drive sales and earnings higher.

Our iShares Transportation ETF (IYT) are typically a leading indicator of economic growth.  And they’ve been on fire lately.  IYT recently hit a high of $141.87… this trade is now up 21.1%.  And it’s closing in on our $145 price target.  Continue holding…

Technology (+3.9%)

The technology sector has bucked the slump in growth stocks.  But it’s really hit and miss between individual companies.  Many of the former hot tech stocks have taken a big hit but the sector has been given a boost by the strong performance of under-valued old guard tech.

Materials (+3.7%)

Materials posted a solid 3.7% gain over the last month.  And the outlook for stable interest rates and economic growth in emerging markets is giving the sector a lift.  In fact, we’re recommending the iShares MSCI Global Metals & Mining Producers(PICK) to profit from more upside in this sector… see the Trade Alert for more details.

Utilities (-1.1%)

Utilities enjoyed a nice run over the last four months.  But the run appears to be over… the sector has fallen 1.1% over the last month and it’s now 4.6% below the 52-week high.  I think it’s safe to say the period of outperformance for this defensive sector has run its course and will likely continue to slump in the weeks ahead.

Portfolio Changes

  • This month we’re buying PICK.
  • Sell QABA for a 6% gain.


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