SET Monthly Issue November 2011

| November 15, 2011

November 2011


Well, it was fun while it lasted.

The S&P 500 moved higher five out of the last six weeks.  The large cap index is up more than 10% over that time.

Clearly, stocks have had an impressive rally.

Will it last?

Unfortunately, the outlook isn’t good.

Remember, the catalyst for the recent rally was the European crisis becoming ‘less bad’.  That was it.

Once the market started moving to the upside, traders jumped onboard and fueled a nice rally.

Now, the market rally has largely played out.  And there really isn’t much of anything to be bullish about.

Unless the market gives traders a reason to keep buying soon, we could see stocks move lower in a hurry.

As I pointed out last month, corporate earnings were our best hope to add fuel to the bull market rally.  But they aren’t living up to expectations.

Of the companies that have reported so far, 62% of them beat analyst estimates. When the bull market was raging over the last few years, around 70% of companies were besting estimates.

And revenues are even worse. Only 59% of companies beat sales estimates last quarter.  It’s the fewest, by far, since the bull market began in 2009.

But corporate earnings guidance takes the cake (and not in a good way).

Nearly 9% of all companies lowered earnings guidance.  And less than 7% raised their guidance.  This was the first quarter since the depths of the credit crisis that more companies lowered guidance than raised it.

Overall, corporate earnings were not impressive.  And guidance is flat out bearish for stocks.

What’s more, the financial news is turning its attention back to Europe.  And the news isn’t good… The debt crisis is spreading to the Eurozone’s second largest economy.

If European improvement was the catalyst for the stock market rally, then a deterioration of the Euro crisis could trigger a massive selloff.

And there’s only one safe haven in times like these…


The European sovereign debt crisis is unlike anything I’ve ever seen… and it’s reaching a boiling point.

The crisis has already claimed two victims… Greece and Italy.

These two countries recently succumbed to their huge sovereign debts.  Greece simply ran out of money and needed a bailout.  Italy is still afloat but they’re only hanging on by a thread.

It’s never a good sign for the economy when we’re talking about bailouts… and it’s about to get worse!

Macro/Economic Trend:  Debt Spreads Are Widening

The bond market has been signaling trouble for Italian debt since early this year. That’s when debt spreads started getting out of whack.

What’s a debt spread?

It’s a bit complicated if you don’t follow the bond market, but I’ll try to keep it simple.

Debt spreads measure the difference between yields on similar bonds issued by different countries.  Countries that are perceived to be safer like the US and Germany have lower bond yields.  And on the flip side, those with more risk have higher bond yields.

It makes sense… nobody’s going to buy a bond from a riskier country unless they get a bigger interest payment to offset the additional risk.

When the spread begins to widen, it’s a big red flag.  Sovereign debt typically trends in the same direction.  It doesn’t matter if it’s the US, Germany, Italy, or whomever.

However, the spread between Italian bonds and those from the US and Germany began to change earlier this year.  And not in a good way.

Over the last several months, the yield on Italy’s sovereign debt has been moving higher.  The yield on a 10-year Italian bond now stands at 6.64%.

But at the same time, yields on German and US debt have seen sharp declines.  The yield on a 10-year US Treasuries stands at 2.01% and German 10-year notes are at 1.8%.

As a result, the spread between the risky Italian debt and the safer US and German debt is now at a record high.

In short, once the debt spread started to widen, it was nearly impossible to reverse.

Money has poured out of Italian bonds into the safer German and US bonds for months.  The wider the spread, the more money that moves.  It’s like a self-fulfilling prophecy…

Italy’s problems are one reason why we’ve seen US Treasuries surge to their recent heights.  And now they could be poised to surge again…

You see, what happened with Italian bonds is now starting to happen with French bonds!

Simply put, this is a European debt contagion.  Debt yields are starting to spiral out of control in one country after another.  And it’s nearly impossible to stop.

Right now, the spread between French and US debt is starting to widen.  It’s nowhere near as wide as the spread between Italian and US debt… yet.  But it looks eerily similar to what happened with Italian debt earlier this year.

As the spreads continue to widen, money is going to flood out of French bonds into US and German bonds.

It’s almost certain to drive down yields on US Treasuries.  That’s great news for anyone owning US Treasuries.  Let’s grab the Vanguard Long-Term Government Bond ETF(VGLT) to profit from the coming surge in US Treasuries.

Fundamentals:  A closer look at VGLT

VGLT invests primarily in long-term US government bonds.  It maintains a dollar-weighted average maturity of 10 to 25 years.

The expense ratio is 0.15%.  And it yields 2.81%.

No top holdings here… This is a pure play on long term US Treasuries.

Technicals:  The charts lead the way

As you can see, VGLT is up a whopping 20% since July.  That’s simply an amazing run for US Treasuries…


We’ll typically see a correction of some sort after a move of this magnitude.  And the type of correction VGLT has had is extremely bullish.

Over the last few months, VGLT has corrected by time.  The ETF didn’t give back hardly any of it gains.  It’s simply held near the highs and waited for the 50-day moving average to catch up with the price.

I’m expecting VGLT to surge higher from this bullish technical setup.

Trade Alert

Buy:  Vanguard Long-Term Government Bond ETF (VGLT) up to $74.15
Recent Price:  $73.22
Price Target:  $81.00
Stop Loss:  $69.00

Remember:  The European sovereign debt crisis is quickly spreading.  VGLT should surge as French sovereign debt troubles drive bond investors into one of the few safe havens left… US Treasuries.  What’s more, VGLT’s chart is in a bullish continuation pattern.  Grab your shares of VGLT before it moves beyond our buy up to price.


Consumer Discretionary (+2.1%)

Retail sales continue to be a bright spot in the economy.  They increased 0.5% in October.  A bit slower than September’s 1.1% gain, but a strong showing none-the-less.

More importantly, the strong retail sales are being reflected in companies’ earnings guidance.  10% of all consumer discretionary stocks raised their guidance this quarter. That’s the highest rate of any sector.

And it’s great news for our SPDR S&P Retail Fund (XRT).  It hit a high of $54.92 this month.  That’s a peak gain of more than 15%.  And we’re well on our way to our $65 price target.  Continue holding for bigger gains ahead.

Consumer Staples (+2.0%)

Consumer staple stocks are keeping pace with the more cyclical consumer discretionary stocks.  Strong retail sales are clearly fueling gains across both sectors.

Our Consumer Staples Select Sector SPDR Fund (XLP) is off to great start.  XLP quickly moved beyond our $31 buy up to price. Continue holding.

Energy (+8.5%)

Energy companies were some of the hardest hit stocks over the last few months.  But they staged a rousing comeback this month.  The sector’s up by a solid 8.5% in the last month.

As usual, the sector’s fortunes are tied to oil.  And the price of oil is absolutely screaming higher right now.  A barrel of west Texas crude has gone from under $80 in early October to nearly $100 today.

Energy stocks have plenty of upside if oil prices continue moving higher.  It’s enough to put the sector back on my radar…

Financials (+5.1%)

Financial stocks finally bounced back this month.  But as long as the European debt crisis continues, I’m not touching this sector with a ten foot pole.

Our iShares FTSE NAREIT Residential Plus Capped Index Fund (REZ) has rebounded nicely.  We’re currently sitting on gains of more than 10%.  Continue holding REZ for bigger gains ahead.

Healthcare (+3.6%)

Healthcare stocks are still off-limits in my book.  And it’s not going to change until the deficit reduction super-committee is done slashing $1.2 trillion in spending.

Remember, Medicare and Medicaid make up a large chunk of the money spent on healthcare every year.  If they recommend steep cuts to those programs, it’s bad news for the entire sector.

I don’t see any alternative… I’m avoiding healthcare stocks for now.

Industrials (+5.4%)

Industrial stocks had a fantastic showing last quarter.  67% of all industrial companies beat analysts’ earnings estimates.  This sector is clearly building bullish momentum.
It will be interesting to see if these stocks can maintain their momentum as the economic slowdown in Europe takes hold.  For now, I’m taking a wait and see approach…

Technology (+0.6%)

Tech stocks have been on a roll lately.  But they ran into technical resistance this month.  The good news is… I’m expecting the sector to push through resistance soon.
Last quarter, two-thirds of all tech stocks beat earnings estimates.  And more than 7.5% of them raised guidance.  What’s more, many tech companies have strong balance sheets with plenty of cash and little debt.

There’s simply too much bullish momentum to contain this sector.

Our SPDR S&P Semiconductor ETF (XSD) is hanging out right around our $49 buy up to price.  If you haven’t already bought XSD, you can pick up these shares on a dip below $49.

The iShares S&P NA Technology-Software Index Fund (IGV) is off to a strong start.  It reached a peak gain of 5.8% last week.  Continue holding for bigger gains…

Materials (+5.0%)

Materials stocks have had a rough time lately.  The sector is still down about 14% from the 52-week high.  And that’s after a 5% gain this month!

Obviously, last quarter wasn’t great.  And it left management with little reason for optimism.  Amazingly, less than 1% of all materials stocks raised their guidance when they reported earnings.  That’s just not going to get it done.

Our one ETF in this troubled sector is the Market Vectors Gold Miners ETF (GDX). It’s largely moving in lock step with the overall sector.  But we could see it breakout if gold prices keep moving higher.  Continue holding GDX for bigger gains.

Utilities (+4.1%)

Utilities are performing valiantly.  And for good reason… Last quarter, more than 10% of stocks in the sector raised their earnings guidance.  Bullish earnings guidance almost always drives stocks higher.  And our Utilities Select Sector SPDR Fund (XLU) didn’t disappoint.  XLU hit a high of $35.47.  That’s good enough for a peak gain of 7.5%.  And we’re still collecting a solid 3.99% annual dividend.  Continue holding for bigger gains ahead.

Portfolio Changes

  • This month we’re buying VGLT


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