SET Monthly Issue September 2009

| September 15, 2009

September 2009


Wow… That’s the only word to describe the roll the stock market’s on.  We’re now into the sixth straight month of unbelievable gains.  The S&P 500’s up 57% from the March low.

What makes this rally so unbelievable is the absence of a significant correction.  And forget about a retest of the lows… this market’s on fire.

But the rally hasn’t made a believer out of everyone.  Some people still insist the rally is going to fail and the market is headed lower.

And I couldn’t be happier.

I’ll start to worry once all of the bears give up and throw in with the bulls.  But as long as there are people who think the market’s going down, I’m staying bullish.

The main reason I’m so optimistic is because the early stages of new bull markets look just like this one.  That’s to say the market started to rally without supporting fundamentals.

But we’re nearing a point where we’re going to need fundamental improvement to support higher stock prices.

But when do we reach that point?

Let’s start by looking at where we’ve come from.

The last six months of stock market gains have been fueled by a few key components.

First off, say what you will about government meddling in the free market (I’m usually not a fan), but their actions saved our financial system from collapsing.  I can’t imagine where we’d be today if more financial firms were allowed to go the way of Lehman Brothers.

Then came our first clue the economy wouldn’t freefall into the abyss.  I’m talking about ‘less bad’ and ‘better than expected’ economic data.  GDP wasn’t contracting as much as everyone feared.  The housing market began to stabilize.  And, retail sales showed resilience.

However, the most important ingredient to keep the rally going has been better than expected Q2 earnings.  It didn’t seem to matter rock bottom analysts’ estimates and cost cutting measures were behind the upside surprises.

The next big hurdle will come from the Q3 earnings that are just around the corner. Here’s want I want to see in the Q3 earnings…

Earnings improvement that doesn’t come from cutting costs.  Cost cutting can’t grow earnings forever.  A return to revenue growth will signal sustainable earnings improvement.

Anything less will probably cause the rally to stall and set the market up for a big correction.  But until we see the Q3 earnings, I don’t see anything standing in the way of this rally.


Don’t look now but the gaming industry is making a comeback.  Not that it was ever really gone.  Although investors had good reason to think the industry was in for a major shakeup.  Gaming companies can’t make money if there’s no one at the tables.

But the industry has weathered the worst of the economic storm better than many expected.  Thanks in large part to cost cutting.

A closer look at the industry reveals it’s composed of a wide range of companies.  It encompasses everything from hotel/resort casinos, to lottery operators, to the manufacturers of slot machines.

The one thing they all have in common is they need people willing to gamble.  In other words, it’s dependent upon discretionary income.  And when the economy took a turn for the worse, lots of people quit gambling and traveling.

Now we’re seeing people start to travel and spend money again.  Just look at the success of discount travel provider (PCLN).  Their stock is up 120% this year on increased demand for leisure travel.

The industry also faced another major issue.  Many of the hotel and casino operators are highly leveraged.  Investors feared many of them wouldn’t be able to service their debt or find new financing.

Now the financial markets have started to thaw.  We’re seeing companies raise capital and extend or exchange debt.  It’s giving these companies much needed breathing room.

The extra time they’ve bought will keep them going as the economy recovers.  And as the economy recovers, people will start vacationing and spending money again.

Macro/Economic Trend:  Growing Middle Class

The best thing the gaming industry has going for it is the growing middle class in developing countries.  Rapid growth in these countries is creating more people with money to spend.

To add fuel to the fire, many of the fastest growing middle class populations are in Asia.  And gambling is an inherent part of many Asian cultures.

It’s a perfect combination with explosive profit potential.

It’s paving the way for growing gambling destinations like Macau.  But many of the legalized gambling markets remain undeveloped.  As the economy recovers, I’m expecting the major players to rollout growth plans for these markets.

But it’s not all about hotels and casinos.

Online gambling is a major contributor to the industry’s growth.  Again, Asia’s new middle class is the fuel.  The number of people online in China tops 300 million.  That’s more than the entire US population!

The bottom line is the gaming industry is growing worldwide.  Better economic conditions are going to revive business in developed markets.  And, Asia’s growing middle class will fuel unprecedented growth in the industry.

We’ve found an ETF uniquely focused on the gaming industry.  It’s the Market Vectors Gaming ETF (BJK).

Fundamentals:  A closer look at BJK

BJK holds 50 gaming industry stocks.  The companies come from 13 different countries.  It includes small, medium, and large cap stocks in casinos, race tracks, sports books, and tech.

Its expense ratio is 0.7%.

The top five holdings and percentage weights for BJK are –

Company Name Ticker % Weight
International Game Tech IGT 8.7%
Las Vegas Sands LVS 6.6%
Wynn Resorts WYNN 5.8%
Genting Berhad GENT 5.3%

Over the last month, institutional holdings are on the rise.  Remember, the big money can really make an industry move.  Right now they’re piling into gaming stocks.  That can only mean good things for the industry.

Technicals:  The charts lead the way

Take a look at the chart of BJK below.

We’re buying BJK on a ‘breakout’.  You can see BJK recently broke through resistance at $24.  It’s held above this level for four consecutive days.  And as you know, once a resistance level’s been broken, it becomes a support level.  This should provide a good low risk and high reward entry point.


The recent breakout continues the uptrend in place since July.  And, increasing relative strength confirms institutional players are moving into the industry.

Trade Alert

Buy:  Market Vectors Gaming ETF (BJK) up to $27.00
Recent Price:  $25.58
Price Target:  $38.00
Stop Loss:  $18.50

Remember:  BJK just broke through resistance around $24 on increasing institutional ownership.  I think the recovery in gaming stocks has huge potential.  But they’re also subject to a high level of volatility.  I’m giving this trade a little more wiggle room than normal.  But I’m also expecting a much bigger return.


I first wrote about the “new normal” for American consumers last month.  I recommended VIS, an industrials ETF, as a play on this trend.  Wouldn’t you know, it’s up over 10% already.

This month we’re going to stay in the same vein but take it in another direction.  I’m talking about a play on the recovery in consumer spending.

Retail stocks have been on fire this year.  In fact, they’re up a whopping 62%.  In large part, the gains have been driven by expectations of better economic times ahead.

But some companies are truly thriving in this environment.  They’re using the economic downturn to “turn the screws” on cash strapped competition.  They’re growing their market share and positioning themselves to make a lot of money as the economy improves.

When we finally come out of the recession, the good companies are going to be rewarded handsomely.

Macro/Economic Trend:  Save Now, Buy Later

There’s always two sides to every argument.  And the debate over how much consumers will spend post-credit bubble is no different.

The argument against a strong economic recovery is the same old story.  Consumers can’t, or won’t, spend enough to be the growth engine they’ve been for decades.

Some experts point to high levels of household debt.  They contend it will take years to bring the debt levels down to a manageable number.

But I disagree.  I think the consumer will adjust to the new rules quickly.  We’re already seeing the consumer shift from a “buy now, pay later” mentality to a “save now, buy later” mindset.

And it’s happening much faster than anyone thought.  American consumers shed a record $21.6 billion in debt last month.  That blew away economists estimates of $4 billion.

I think the consumer is going to come out of this crisis much better off.  It’s basically force-feeding a shift away from credit card dependency.  It will hurt sales in the short run.  But in the long run, consumers will have more money to spend on stuff.

Here’s why.

The monkey on the consumers back is interest payments on credit card balances.  But once consumers have paid down debt and put away some savings, they aren’t going to continue to save, save, save.

They’ll use their savings to buy stuff.  And they’ll be able to do it without a credit card tacking on 20% interest.

Big picture this is a very good thing for retailers and consumers.  The ETF I like best in this industry is the SPDR S&P Retail ETF (XRT).

Fundamentals:  A closer look at XRT

XRT holds 61 retail stocks.  They include small, medium, and large cap stocks.  This ETF is very evenly weighted with most stocks getting between 1% and 2% weighting.

Its expense ratio is relatively small at 0.35%.

The top five holdings and percentage weights for XRT are –

Company Name Ticker % Weight
Office Max OMX 2.4%
Nordstrom JWN 2.0%
Whole Foods Market WFMI 2.0%
Priceline PCLN 2.0%
Tiffany TIF 2.0%

XRT also holds a number of smaller retailers who are shining bright.  They’re posting their best earnings even as the rest of the economy struggles.  These companies have a lock on innovation, style, and price.  The three main catalysts for retail growth.  Now as the economy improves, it should boost earnings across the board.

Technicals:  The charts lead the way

Take a look at the chart of XRT.  You’ll see it’s in a long term uptrend dating back to the March low.

In fact, the 20-day moving average has supported the price on any small pullback.


The strong price action over the last few weeks has XRT racking up gains much faster than the S&P 500.  This relative strength is a good sign institutional investors are putting money to work in this sector.

All in all, it’s a great technical setup.

Trade Alert

Buy:  SPDR S&P Retail ETF (XRT) up to $34.75
Recent Price:  $33.00
Price Target:  $41.00
Stop Loss:  $28.00

Remember:  XRT is in a strong uptrend.  It’s being pushed higher by some of the smaller companies who are thriving in the economic downturn.  A good Q3 earnings period should push XRT higher.  But if Q3 numbers disappoint… We could finally see a pullback.


Consumer Discretionary (4.6%)

Investors’ fears about the economy sent consumer stocks tumbling earlier this year. This set the stage for a big rally once fears began to subside.  And, we got it.  But we’re still a long way from the finish line.

We’re adding the Market Vectors Gaming ETF (BJK) and the SPDR S&P Retail ETF(XRT) to ride this ongoing trend.

Consumer Staples (3.8%)

Staples posted a nice gain this month.  The sector’s moving higher on better than expected news on the consumer.  But they’re still not able to keep up with the more cyclical discretionary stocks.

Staples are a great safe haven in tough economic times.  But they don’t have the upside we’re looking for now that the economy’s recovering.

Energy (5.7%)

Energy continues to be all about oil.  And oil prices are being dominated by technicals…

Right now there’s heavy resistance around $75.  Oil has failed to break through this level on four separate occasions.  And support from the moving averages is steadily trending up.  The range gets a little tighter every week.

A strong breakout from the current range seems more likely every day.  The breakout could easily move oil prices by $10 one way or the other.

Financials (2.0%)

After locking in a quick 28% profit on our banking ETF (KBE), the financials have been in a holding pattern.

The recent news could be weighing on investors’ moods.  The ranks of the FDIC watch list of troubled banks swelled to over 400.  And we’re nearing the one year anniversary of Lehman Brothers’ collapse.

Investor sentiment will need to improve before we see this sector get back on track.

Healthcare (3.5%)

Healthcare stocks have managed a slow and steady climb over the past few months. I’m inclined to think it’s because the White House is losing the battle for healthcare reform.

However, the uncertainty created by the threat of government intervention will keep this sector under wraps.  I’m keeping a close eye on this sector for a potential trade in the months ahead.

Industrials (6.6%)

We’re off to a great start on our most recent recommendation.  The Vanguard Industrials ETF (VIS) is already up 10%!

The rally can be traced to better than expected economic data.  In the last week alone, we had multiple reports showing economic improvement.  The ISM manufacturing report registered the first month of expansion since January ’08.  It looks like everything’s ‘a go’ for bigger profits ahead.

Technology (5.0%)

The rally in technology stocks heated back up in the last few weeks.  And it’s been great for our tech ETFs.  In fact, I increased the price target for the iShares S&P North American Technology – Multimedia Networking Index Fund (IGN) to $32.

Technology is the one sector where I’m not inclined to take profits early.

This sector’s on the cutting edge of the economic recovery.  And their products also help companies drive down costs and increase productivity.  This should keep the sector flying high even if the recovery comes slower than expected.

The other aspect I like is management teams have already dealt with the aftermath of a market collapse… the dot-com bubble.  This gives tech companies’ management the upper hand compared to other industries.

Materials (3.5%)

The stories of China moving to lock up supplies of basic materials just keep coming. The most recent commodity to skyrocket is nickel.  It’s up over 100% since March.

In this year alone, China’s spent over $6 billion buying up Australian companies.  And Australia’s economy is dominated by commodities.  It’s not hard to connect the dots…

Utilities (-0.3%)

Utility companies were the only sector to fall back this month.  It’s not surprising considering the headwinds the industry is facing.

Investors are ripe with optimism.  They’re looking to cyclical industries to deliver big gains as the economy recovers.  This leaves defensive sectors like utilities on the outside looking in.

And you can throw in the uncertainty surrounding how cap-and-trade will affect the bottom line as well.

I think utilities will continue to lag the rest of the market as long as the economic data points toward recovery.

Portfolio Changes

  • This month we’re buying BJK and XRT…
  • Move MOO, VIS, and XME to ‘Hold’ status
  • Increase IGN price target to $32


Category: SET Monthly Issues

About the Author ()

Comments are closed.