SET Monthly Issue November 2010

| November 16, 2010

November 2010


I was caught off guard when I first heard the news.  Individual investors are finally returning to the stock market.

According to EPFR Global, retail investors have plowed $2 billion into stock funds since September.

Simply stated, this is a big shift…

Up to September, individual investors were pulling money out of the market at an alarming rate.  Last year alone, retail investors pulled nearly $23 billion out of the market.

Now the money flow is reversing. The result?

The influx of retail investor money has sent the S&P 500 surging to new “recovery rally” highs.

But more importantly… Does the return of retail investors mean the markets are near the top?

Many long time professional investors watch retail investors and do the opposite. Retail investors often have the uncanny ability to do the wrong thing at the wrong time.

So are the retail investors wrong?  Are they buying at the top?

Not if the leading economic indicators and the Fed have anything to say about it!

In short, the leading economic indicators are bullish.

The Weekly Leading Index (WLI) published by the Economic Cycle Research Institute shows economic growth is accelerating.  In other words, the economy should be stronger in six months than it is today.

That’s great news for stocks and individual investors.

And this is only the beginning!

Remember, the Fed has just begun its second round of quantitative easing (QE2).

The general consensus says QE2 is already priced into the markets.  But more often than not, the prevailing wisdom is just plain wrong.  I think the impact QE2 will have on the economy and the market is still being underestimated.

I think the markets will run much higher from here.

Don’t overlook how stocks performed from March of 2009 to April of 2010 (the S&P 500 shot up 83%).  This was when the Fed was buying Treasuries and Mortgage-Backed Securities from the first round of QE.

Now the Fed is buying Treasuries again.  And they’ll continue to buy more through the middle of 2011.  (And beyond if inflation is still too low and unemployment is too high.)

The way I look at it, you can’t fight the Fed.  And the Fed’s determined to cause asset price inflation.

Right now we’re seeing a post QE2 announcement countertrend rally.  The US Dollar is strengthening and stocks have pulled back a bit off their highs.

This looks like a great buying opportunity to me.

The areas of the market most impacted by the Fed action are commodity prices like oil, grains, and precious metals.  Our ETF recommendation this month should skyrocket right along with oil prices.


It’s no secret small cap stocks can deliver huge gains.  It’s just easier for a $1 billion company to grow to $2 billion than it is for a $50 billion company to double.

And with oil prices surging to nearly $90 per barrel, small energy companies are reaping the rewards.

As I told you earlier, the Fed is using quantitative easing (QE) to boost economic growth.  By printing more money to buy Treasuries, the Fed is also devaluing the US Dollar.

As the value of the US Dollar falls, the price of commodities traded in US Dollars rise. This alone has the potential to send oil prices higher.  But I think there’s something even bigger that will cause oil prices to rocket higher.

Macro/Economic Trend:  Demand Outpacing Supply

Chinese demand is pushing oil prices higher…

The economic boom in China has led to a record number of new car owners. Amazingly, it’s now the world’s largest automobile market.  Chinese drivers are expected to buy a mind boggling 17 million new cars… just this year!

And along with all the new cars, demand for fuel to power those cars is skyrocketing.

In fact, imports of gas and diesel are surging.  They shot up 18% last month alone. And imports have been rising steadily for months leading up to the most recent report.

Here’s the deal…

Chinese refineries are going full tilt to meet the demand.  But they just can’t keep up. Their only choice is to import more gas and diesel.

According to the Wall Street Journal, “there are massive shortages of diesel right now”.

Analysts are predicting China will be a net importer of diesel and gas for the foreseeable future.

Here’s the kicker…

The last time China was a net importer of diesel was leading up to the Beijing Olympics in 2008.  This demand helped push oil to its all time record of almost $150 per barrel.

As you can see, increasing demand from China and a weak US Dollar are combining to create a perfect storm for oil prices.

Let’s grab the PowerShares S&P SmallCap Energy Portfolio (XLES) now to profit from surging oil prices.

Fundamentals:  A closer look at XLES

XLES holds 22 small cap energy stocks.  The index is made up of the energy stocks in the S&P SmallCap 600 index.  The top holdings are closely tied to oil and gas production.

The expense ratio is 0.29%.

The top five holdings and percentage weight for XLES are –

Company Name Ticker % Weight
SM Energy SM 12.31%
Oil States International OIS 11.42%
SEACOR Holdings CKH 8.73%
World Fuel Services INT 5.81%
ION Geophysical IO 5.54%

Technicals:  The charts lead the way

XLES is in a strong uptrend over the last few months.  It has broken out to a new all time high.  But it’s a relatively new ETF.  It just began trading in April of this year.

In order to get a better idea of the technical setup, I dug into the stock charts of the underlying securities.

I found a number of very bullish charts.  Some stocks like SM Energy (SM), Oil States International (OIS), and SEACOR (CKH) are already breaking out new 52-week highs.

There are also others like Swift Energy (SFY) and Stone Energy (SGY) that are on the verge of breaking out.


It looks like there is still plenty of juice in XLES.  It should continue its recent surge as more stocks breakout to new 52-week highs.

Trade Alert

Buy:  PowerShares S&P SmallCap Energy Portfolio (XLES) up to $30.00
Recent Price:  $28.40
Price Target:  $39.00
Stop Loss:  $25.50

Remember:  XLES is surging higher along with oil prices.  The initial cooling off period after the Fed’s QE2 announcement has created a great buying opportunity.  But we could still see prices correct more in the very short term.  Long term increased demand for gas and diesel from China will drive oil prices higher.

Consumer Discretionary (+3.7%)

US retail sales surged 1.2% in October.  A half point more than economists were expecting.  Clearly the American consumer is alive and spending.

The sector has posted four consecutive monthly gains.  And investors are looking for a strong holiday shopping season to spur shares to new heights.

Our position in iShares Dow Jones U.S. Consumer Services Sector Index Fund(IYC) hit a new peak gain of more than 12%.  Continue holding IYC for further upside.
Consumer Staples (+0.3%)

Consumer staples posted a modest gain.  But the defensive sector continues to lag more economically sensitive sectors.

I just don’t see a catalyst for consumer staples to lead the markets at this point… But we’ll keep our eye on it.

Energy (+6.3%)

Energy stocks continued their impressive run.  The 6.3% gain was the largest of any sector this month.  Oil flirted with $89 per barrel last week, its highest price since October 2008.

Our Dow Jones U.S. Oil Equipment & Services Index Fund (IEZ) hit our $50 price target a little over a week ago.  We sent out a special sell alert to lock in our 25% gain.  Congratulations on a successful trade!

Our Guggenheim Global Solar ETF (TAN) has gotten off to a slow start.  But the fundamentals are solid and the uptrend is still in place.  Go ahead and buy TAN up to $9.50 if you haven’t already.

We’re adding the PowerShares S&P SmallCap Energy Portfolio (XLES) into the mix this month.  See above for more details…

Financials (+4.0%)

Financials posted a solid 4% gain this month.  The gain came after the Fed announced plans for QE2.  Clearly investors are expecting bank profits to get a nice boost from the Fed’s latest actions.

Our SPDR KBW Bank ETF (KBE) is still below our buy up to price.  Obviously banks are facing headwinds from negative investor sentiment.  The good news is legendary investor Warren Buffett recently added a $52 million position in Bank of New York Mellon (BK).  Clearly the Oracle of Omaha sees some banks as undervalued.  And we do too!  Go ahead and buy KBE up to $23.50 if you haven’t already.

Our iShares Dow Jones U.S. Real Estate Index Fund (IYR) hit another peak of over 18%.  Since then, REITs have pulled back a little but the uptrend is still in place.  Hold tight for further gains.

Healthcare (-0.7%)

The three month rally in healthcare stocks came to an end this month.

Our iShares Dow Jones U.S. Pharmaceuticals Index Fund (IHE) and First Trust Biotechnology Index Fund (FBT) are holding onto most of their recent gains.  In fact, they’re the best performing industries within healthcare.  I’m expecting drug stocks to make another push higher.  Hold tight for now.

Industrials (+0.6%)

Industrials advance slowed to a snail’s pace this month.  The sector wasn’t able to break through resistance of the April highs.  Now the sector has begun to pull back.

The good news is… We locked in gains on 15% in IYT and 18% in FAA on the way up.

I think the Fed’s weak US Dollar policy is good news for US manufacturers with substantial foreign sales.  I’ll be keeping an eye on this sector for possible re-entry on the pullback.

Technology (+1.0%)

Tech stocks were having a great month.  Then Cisco (CSCO) dropped a bomb. Management cut revenue growth guidance to 3%-5%.  It’s well below analysts’ estimates.  The news sparked concerns spending on new technology could disappoint across the entire sector.

Our iShares S&P North American Technology-Software Index Fund (IGV) managed to avoid the Cisco fallout.  We hit a peak gain of 8% and passed our buy up to price, so we’re moving IGV to hold.

Our SPDR S&P Semiconductor ETF (XSD) is continuing the uptrend off the August low.  But headwinds from the Cisco bomb are cutting into our recent gains.  I’m still optimistic chip companies will deliver a solid performance in the end.  Hold tight for further gains ahead.

Materials (+2.5%)

Materials stocks have benefited from the collapse of the US Dollar over the last few months.  Now the US Dollar is strengthening and materials stocks are pulling back.

Our First Trust ISE Global Platinum Index Fund (PLTM) has seen some big price swings in the first month.  But I think the best is yet to come.  It’s moved beyond our buy up to price so we’re moving PLTM to hold.

Utilities (-1.8%)

Utilities gave back some of their recent gains this month.  But there’s no cause for alarm.  In fact, fear of a bubble in bonds could drive income investors into high quality dividend stocks… And that would be great news for Utilities.

Our Utilities Select Sector SPDR Fund (XLU) is holding steady near its recent highs. If income investors finally make the move into equities, we’ll be sitting pretty.  Hold tight for now.

Portfolio Changes

  • This month we’re buying XLES
  • Move IGV and PLTM to Hold
  • Sold iShares Dow Jones U.S. Oil Equipment & Services Index Fund (IEZ) for a 25% gain

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