SET Monthly Issue October 2014

| October 21, 2014

October 2014


October is living up to its billing as one of the most volatile months for stocks.

After reaching a new all-time high of 2,019 in September, the S&P 500 tumbled 10% lower over the next four weeks.

As it so often does, the pullback triggered fears of a 20% correction or a bear market among investors.

But those fears were unfounded.

The way I see it, the pullback was largely driven by price action and investor sentiment.

When the pullback began, there were several technical indicators about momentum and market breadth that turned bearish at the same time.

This was compounded by investor fears about the end of the Fed’s stimulus program, interest rates, geopolitical tensions, and Ebola.

As a result, many investors that actively manage their portfolio simply closed out their open positions during the pullback.

But here’s the thing…

The stock market has come racing back over the last two weeks.  And none of the fundamental data has changed.

Right now, the US Dollar is strong, oil and other commodity prices are down, global economic growth is sluggish, and the US looks like the safest place to be.

That’s essentially the same fundamental situation as when stocks were falling a few weeks ago.  That means there’s something other than fundamental data driving the selloff and ensuing rebound.

According to the AAII Investor Sentiment Survey, bullish sentiment toward stocks increased 7% last week to 49.7%.  That’s 15% higher than it was at the beginning of the month and it’s the highest level of optimism since the end of August.

I believe that the recent bout of investor sentiment driven volatility has largely played out.  Investors are starting to take their cues from fundamentals once again.

And that means investors are looking at current earnings and forecasts…

So far 75% of the 208 S&P 500 companies that have reported 3rd quarter earnings have beat earnings per share estimates.  On average, those earnings have been 3.8% better than expected.  Those are both running ahead of the pace we have seen in recent quarters.

The bad news is earnings estimates for the 4th quarter and 2015 have been weakening.

The majority of the weakness can be found in energy stocks that are projecting much lower profits after the price of oil has fallen more than 20% from more than $105 per barrel earlier this year to around $80 per barrel today.

That leads me into this month’s trade…

The drop in oil prices is hard on energy stocks, but it’s almost universally good for a different group of stocks…


The holiday shopping season is the time of year that most retailers make a big chunk of their annual profits.  And this year is shaping up to fall in line with these historical patterns of seasonality.

One thing’s for sure… people are spending more money today than ever before.

Consumer spending rose 0.5% in August as personal income rose 0.3%.  But the recent bout of fear that has swept through Wall Street has also found its way into future expectations about consumer spending.

After healthy growth in August, consumer spending is expected to increase 0.1% in September.  And the outlook isn’t much better for the rest of the year.

What’s more, we’ve already seen Amazon (AMZN), Wal-Mart (WMT) and eBay(EBAY) cut their 4th quarter sales forecast.

In other words, expectations for retailers are really low right now.  And they’re virtually assured of beating these lowered estimates.

Here’s why…

Macro/Economic Trend:  A Boost For Retailers

According to The National Retail Federation (NRF), the average US consumer will increase holiday spending by 5% this year to $804.42.

This makes sense given the fact that there are 2.7 million more people working this year than at this time last year.  And don’t discount the impact of lower prices at the pump.  While the real impact can be marginal, it can help lift consumer sentiment.

In fact, consumer confidence is now at its highest levels in seven years.

Falling food and gas prices, rising home values, and an improving job market are all contributing to a consumer that’s ready to spend this holiday season.

And a recent poll from Gallup confirms these expectations from the NRF.  The poll shows consumers are planning to spend the most on Christmas shopping since 2007.

Here’s the bottom line…

Retail stocks have been lagging behind the S&P 500 this year.  Expectations are low because retailers are cutting their sales forecasts for the fourth quarter.  And the consumer confidence data and recent polls show that consumers are going to increase holiday spending much more than expected.

This is a perfect situation to add exposure to retailers.

The ETF I like to profit from this trend is the Market Vectors Retail ETF (RTH).

Fundamentals:  A closer look at RTH

RTH tracks the overall performance of 25 of the largest U.S. listed, publicly traded retail companies.

It currently consists of 26 stocks.  The stocks are weighted according to market capitalization.  The expense ratio is 0.35%.  It has a dividend yield of 0.98%.

The top five holdings and percentage weight for RTH are –

Company Name Ticker % Weight
Wal-Mart WMT 10.42%
Amazon AMZN 8.14%
Home Depot HD 8.13%
CVS Caremark CVS 7.79%
Lowe’s LOW 5.16%

Technicals:  The chart leads the way

RTH is currently trading for $63.40.  It’s up 4.0% year-to-date with all of those gains coming in the last few months.


After very strong performance in 2012 and 2013, RTH has been in a period of consolidation in 2014.  As you can see, the 200 day-moving average has been a strong level of support for RTH during this time.

I believe the recent price action is indicative of a breakout from the period of consolidation.  Notice how RTH broke out to a new high.  Then it pulled back to test support of the previous resistance level and began to move higher again.

I think we’ll see another period of rapid price appreciation for RTH in the weeks ahead.

Trade Alert

Buy:  Market Vectors Retail ETF (RTH) up to $65.00
Recent Price:  $63.40
Price Target:  $75.00
Stop Loss:  $55.00

Remember:  Retail stocks are in a unique position of being relatively cheap, hated by most investors, and in an uptrend.  This is a unique situation that doesn’t occur very often.  When it has happened in the past, it typically leads to big gains.  And I’m expecting a revival of retail stocks to spark another surge to the upside in the weeks ahead.


Consumer Discretionary (-1.6%)

The consumer discretionary sector has been out of favor with investors this year.  But there are several favorable trends that are lining up in favor for the sector.  In fact, we’re recommending the Market Vectors Retail ETF (RHT) to profit from very powerful fundamental, technical, sentiment, and seasonal factors… see Trade Alert for more details.

PowerShares Dynamic Media Portfolio (PBS) and PowerShares Dynamic Leisure & Entertainment Portfolio (PEJ) are the other ETFs that fall into this sector. They’ve both experienced dramatic turnarounds during the last few weeks.  These ETFs should also benefit from the same tailwinds that are helping our new recommendation.  Continue holding.

Consumer Staples (+1.5%)

Consumer staples added 1.3% over the last month.  It’s not surprising to see this defensive sector perform well in times of volatility and fear.

Our First Trust Consumer Staples AlphaDEX Fund (FXG) is on the verge of breaking out to a new high… again.  As expected, the recent pullback didn’t last long.  I’m expecting the same strong consumer data to help push FXG to a new high in short order.  Continue holding.

Energy (-9.3%)

Energy stocks have gotten crushed over the last few months.  There are several reasons for the recent slump in oil prices.  There are the typical supply and demand imbalances that occur from time to time.  Right now new supply is coming online faster than demand is growing.  And it’s pressuring oil prices lower.

Then there are the much more nefarious stories about OPEC and Big Oil agreeing to allow oil prices to fall in order to put the smaller oil and gas companies out of business. Then they can step in a buy up the leftover assets for pennies on the dollar and reassert control over the price of oil.

Whatever the case may be, the recent action has unleashed a wave of short selling against oil and gas stocks in the unconventional oil and gas space.

Our Market Vectors Unconventional Oil & Gas ETF (FRAK) fell below our $26.50 stop loss.  That’s our cue to sell.  I’m sad to see the unconventional oil and gas companies come under fire.  They’ve been one the biggest engines of job creation in the US over the last few years.  We should all hope that this sector can survive the drop in oil prices.

It’s not surprising to see our Guggenheim Solar ETF (TAN) make a big move lower while oil prices fell and the stock market sold off.  But I’m surprised to see TAN hasn’t rebounded quicker as stocks have recovered over the last few weeks.  Nevertheless, solar stocks seem to be undervalued relative to their growth potential.  Continue holding for more upside.

Our Morgan Stanley Cushing MLP Hi Income ETN (MLPY) has been a wild ride over the last few weeks.  It’s currently about 9% below the September highs.  MLPs are insulated from gyrations in oil prices but they are susceptible to changes in demand for their services.  Some are speculating that US production growth will falter with oil prices hovering around $80 per barrel.  I think oil prices will need to fall below $70 before we see production scaled back.  That means MLPY will continue collecting their fees and paying their dividends.  Continue holding…

Financials (-1.5%)

Financials have been moving in lockstep with the overall market recently.  TheFinancial Select Sector SPDR Fund (XLF) is another sector that falls into the category of being cheap, hated, and in an uptrend.  Continue holding.

Healthcare (+1.2%)

Healthcare was once again one of the strongest sectors last month.  The First Trust Health Care AlphaDEX Fund (FXH) is on the verge of making a new high.  Healthcare is clearly one sector investors are willing to hold onto and invest more money in right now.  The bullish momentum is showing no signs of abating.  Continue holding.

Industrials (-0.2%)

Industrials have been up and down over the last month.  They ended up finishing the month at basically the same spot they’ve been in over the last few months.  The sector is being pulled in many directions by different economic data.

For instance, the weakness in the global economy is weighing on international growth. But strong US growth is helping.  The strong US Dollar is a headwind for sales but it also drives down energy costs that can be viewed as a tailwind.

As a result, we’ve seen industrial stocks in a volatile trading range throughout most of the year.

Technology (-1.9%)

Tech stocks have been one of the brightest spots for investors this year.  And despite the recent market volatility, I believe that Global X Social Media Index ETF (SOCL) and First Trust NASDAQ-100 Technology Sector Index Fund (QTEC) offer huge upside in the fourth quarter.  Grab your shares of SOCL or QTEC before they move beyond the buy up to price.

Materials (-6.2%)

Materials suffered a dramatic selloff as global economic growth sputtered and the US Dollar strengthened.  Needless to say, materials stocks are now lagging well behind the overall market.  And that’s unlikely to change unless we see an uptick in global economic growth.

Utilities (+5.2%)

Utilities have been the surprise sector of the year.  Interest rates have remained low and look to remain low for at least another year.  As a result, investors continue to flock to utilities stocks for their safe and secure dividend payments.

Portfolio Changes

  • This month we’re buying RTH.
  • FRAK sold on 10/10/14 after triggering stop loss.


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