SET Monthly Issue October 2011

| October 18, 2011

October 2011


It’s earnings season!

Finally, we can get away from all of the negative macroeconomic stuff… You know, all the really fun stuff like a credit crisis in Europe, a recession in the US, and a manufacturing slowdown in China.

It seems like it’s all we’ve talked about for months… And the longer we talk about it, the more pessimistic everyone becomes.

Now, we can dig into how companies are actually performing.  It’s a novel idea… but growing revenue and earnings still counts for something.

And if things work out right, we could see the market’s rally even without improvement on the macro level.

You see, strong earnings this quarter will go a long way toward healing investor psyches.  Simply put, there’s nothing like upside earnings surprises to light a fire under traders.

I’ve seen it time and time again…

Traders get hammered by negative information.  Their mindset is dominated by the fear of losing money in a market crash.  So, they unload risky assets like stocks and buy safe ones like Treasuries.

Then an event, like great earnings, causes something change.

And just like that, traders’ emotions turn 180 degrees. They’re no longer dominated by the fear of losing money.  Instead they’re gripped by fear of missing out on the next market rally.  So, they sell their safe investments and add risky investments like stock…

Thing is, fundamentals don’t need to change.  It’s purely psychological… so, stocks can rally even if the macroeconomic data is still bad.

The bottom line is we’re sitting at a crossroads of ‘risk on’ and ‘risk off’.

A round of better than expected earnings will push traders toward adding risk again. And once the fear of missing out on the next rally overtakes the fear of a market crash, look out – we could see a massive rally to close out the year.


We’ve bought into the cloud computing revolution before.  Last year we pocketed gains of 25% as cloud computing technology sent software stocks soaring.

In short, cloud computing is internet based computing.

Cloud computing is using web-based tools through a web-browser. It’s just like using software installed on your own computer, but without the need to store all the data locally.

Over the last few years, the rapid development of fast and reliable communications networks has made cloud computing possible.  (You weren’t going to cloud compute with an old dial up modem.)  Now it’s exploding in popularity.

And the software industry providing cloud computing services is in overdrive.

Macro/Economic Trend:  More productivity

It’s no secret businesses everywhere try to get the most they can out of every worker.

And with the economy slowly clawing its way back to life, many are focused on improving productivity to boost the bottom line.

One way companies are boosting productivity is by deploying new software.

Thanks to the cloud computing revolution, the cost and time to implement new technology is shrinking.  Today, companies are able to rapidly deploy new technologies and reap the profits virtually overnight.

The low cost of new cloud computing solutions makes them very popular with companies of all sizes.  And from a cash flow and scalability perspective: the cloud’s a great business move.

It works out to a win-win situation for everyone.

The software companies continue to get paid as long as the customer uses the services.  And their customers are able to implement new technology to improve their business operations without hefty upfront fees.

It’s easy to see why there has been such rapid adoption of cloud computing solutions.

And here’s the best part… cloud computing is just ramping up.  As more businesses shift to the cloud, software company sales and earnings will continue to grow rapidly. And strong growth in these two categories will help drive stocks higher.

Let’s jump back into cloud computing with the iShares S&P North American Technology-Software Index Fund (IGV).

Fundamentals:  A closer look at IGV

IGV holds 55 of the top US based software firms.

The expense ratio is 0.48%

The top five holdings and percentage weights for IGV are –

Company Name Ticker % Weight
Microsoft MSFT 10.28%
Oracle ORCL 9.08% CRM 6.51%
Symantec SYMC 5.56%
Adobe Systems ADBE 5.46%

Technicals:  The charts lead the way

IGV is in an emerging uptrend.  Take a look at the chart below…


Over the last three months, IGV has set a series of higher highs and higher lows.  This suggests IGV is starting a new uptrend…

However, we need to see one more retest of the support zone lows.  Typically you want a series of three higher highs and three lower lows to declare the beginning of new uptrend.

But this setup is just too good to pass up.

Trade Alert

Buy:  iShares S&P NA Technology-Software Index Fund (IGV) up to $59.00
Recent Price:  $59.00
Price Target:  $67.50
Stop Loss:  $47.50

Remember:  IGV is benefiting from two separate positive catalysts.  One is the stunning growth of cloud computing.  The other is an emerging uptrend in tech stocks. Together, these catalysts have the potential to deliver massive gains over the next few months.

However, in the short run I’m expecting IGV to pull back.  The most likely stopping point will be either the 65-day moving average or the uptrend support.  In other words, IGV could pull back to $55 or $51.

Obviously, if you wait for the pullback, you could buy in at a better price.  But there’s no guarantee IGV will pullback.  You could end up missing out on this trade altogether. Either way, I think IGV will be much higher down the road.


It’s been a long summer.

Fear of an economic slowdown or even another credit crisis has kept stock investors on the sidelines.  But we’re seeing signs of life…

Macro/Economic Trend:  Signs of life

Retail sales are showing the economy still has life.  Last month, sales came in better than expected, increasing 1.1%.  And the August number was revised from nothing to a gain of 0.3%.

In fact, sales grew at the fastest rate since February.  That’s clear cut evidence the US economy isn’t going back into recession without a fight.

The strongest area of the report was motor vehicles.  But more importantly, the growing sales aren’t confined to just one area of the economy.  Nearly every sector had sales gains in September.

When excluding autos, retail sales increased by a rock solid 0.6%… the strongest increase since March!

Clearly, US consumers are continuing to spend money despite the slowing economy. And that’s a great sign for the economy and stocks.

Let me explain…

As you know, consumer spending accounts for nearly 70% of the US economy.  So, as long as consumers are spending, the economy should keep growing.

What’s more, even if the economy does fall into a recession, consumer spending should remain strong.  And the area that should remain strongest is consumer staples.

People still have to buy basic necessities… And that’s not going to change no matter what the economy does.

Let’s buy the Consumer Staples Select Sector SPDR Fund (XLP) now to profit from the surge in consumer spending.

Fundamentals:  A closer look at XLP

XLP holds 44 S&P 500 companies who are engaged in food & staples retailing, household products, food products, beverages, tobacco, and personal products.
The expense ratio is 0.2%. And the dividend yield is 2.8%.

The top five holdings and percentage weights for XLP are –

Company Name Ticker % Weight
Proctor & Gamble PG 14.57%
Philip Morris Intl PM 9.72%
Wal-Mart WMT 7.95%
Coca-Cola KO 7.44%
Kraft Foods KFT 5.07%

Technicals:  The charts lead the way

XLP is in a solid long term uptrend.


As you can see, XLP has trended steadily higher over the last few years.  And over the last year, it’s up about 7.5%.

More importantly, XLP recently pulled back to the 50-week moving average.  The last time XLP pulled back to this level it spring boarded 26% higher over the next year.

I think XLP is setting up for another surge higher.  As such, the pullback to the 50-week moving average looks like a great buying opportunity!

Trade Alert

Buy:  Consumer Staples Select Sector SPDR Fund (XLP) up to $31.00
Recent Price: $30.89
Price Target: $38.00
Stop Loss: $25.00

Remember:  Consumer staples are benefiting from an uptick in consumer spending. And XLP recently pulled back to the long term support of the 50-week moving average.  The last time it hit this level XLP went onto rack up gains of more than 26% over the next year.  This looks like a great buying opportunity to me.  Go ahead and grab your shares now.


Consumer Discretionary (+2.4%)

Retail sales surprised to the upside in September.  That’s a clear indication the economic slowdown hasn’t crushed the consumer yet.  And judging by the way things are shaping up, we’ll likely see retail sales remain strong going forward.

Our SPDR S&P Retail Fund (XRT) is up more than 7%.  The recent rally pushed our ETF past our $49 buy up to price.  As a result, I’m moving XRT to a hold.

Consumer Staples (+0.1%)

Consumer staple stocks have held up better than most stocks lately.  It shouldn’t come as a surprise.  By and large, these companies have strong balance sheets and steady cash flow.  And that’s just the type of investment that does great in a crisis.
However, many of these stocks were dealt heavy losses in the August correction.  But true to form, they’re bouncing back quickly.

I think consumer staple stocks have a bright future.  I’m recommending Consumer Staples Select Sector SPDR Fund (XLP) again this month… see Trade Alert 2 for more details.

Energy (-0.7%)

Energy stocks can’t catch a break.  They’ve been crushed between the dual hammers of a strong US Dollar and falling oil prices.  As a result, investors are selling first and asking questions later.

Look, demand for energy isn’t going away.  At some point, we’ll be able jump back into this sector and make a killing.  However, we’re not there yet.  I’m steering clear of energy stocks for now.

Financials (-2.3%)

Financial stocks took another beating this month.  Simply put, the sector is a mess. Hopefully earnings season will shed some light on the sectors strengths and weaknesses.

But at this point, I’m not interested in owning financial stocks.  In short, there are better opportunities than financial stocks right now.

Our iShares FTSE NAREIT Residential Plus Capped Index Fund (REZ) gave us another scare earlier this month.  The price collapsed as investors began to fear the European debt crisis began to boil again.  But as long as we don’t have a repeat of the 2008 financial crisis, residential REITs should be just fine. Continue holding REZ…

Healthcare (-0.4%)

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 (+0.7%)

Industrial stocks have stabilized.  But there isn’t much to get excited about. Industrials are cyclical business that rise and fall with the economy.  And right now the economy is slowing.

The good news is manufacturing stocks are already pricing in a mild recession.  As long as Europe doesn’t cause a credit crisis, we may be nearing a bottom in industrials.

Technology (+4.1%)

Technology stocks are showing relative strength over the last few months.  In fact, tech is best performing sector over the last month.

Clearly, tech companies are doing a great job of growing profits in a difficult economy. They’re profiting from the growth in cloud computing as well as the technology adoption lifecycle.

Our SPDR S&P Semiconductor ETF (XSD) is off to solid start.  Our ETF is closing in on our $49 buy price.  Make sure to pick up your shares before it’s too late.

I’m also recommending the iShares S&P NA Technology-Software Index Fund(IGV) this month.  Many of the software companies in IGV are cleaning up as cloud computing technologies hit the mainstream… see Trade Alert 1 for more details.

Materials (-3.0%)

Materials stocks are getting crushed.  They fell another 3% this month.  But they’re actually on the comeback trail after being down a lot more a few weeks ago.

Could this be the bottom for materials stocks?  In a word… Yes.  But all bets are off if Europe takes a turn for the worse.

Our Market Vectors Gold Miners ETF (GDX) is as volatile as ever.  It continues to ride up and down along with gold prices.  And over the last two months the price of the yellow metal hit record highs high of over $1,900 and lows of under $1,600.  That’s some serious volatility!

However, I believe we’ll see gold mining stocks stabilize and move higher.  Continue holding GDX for bigger gains.

Utilities (0.0%)

Utilities are a great refuge in a sea of uncertainty.  Our Utilities Select Sector SPDR Fund (XLU) was unchanged over the last month.  And we’re collecting a solid 3.99% annual dividend.  I’ll take that in this crazy market any day!  With XLU still trading below our buy up to price, go ahead and buy it up to $34 if you haven’t already.

Portfolio Changes

  • This month we’re buying IGV and XLP.
  • Move SPDR S&P Retail Fund (XRT) to hold.

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