SET Monthly Issue September 2010

| September 21, 2010

September 2010


Wouldn’t you like to know the future?

It sure would make choosing the right investments a whole lot easier.  Knowing the future is great, but there are limits.  I definitely don’t want to know how I’ll kick the bucket…

But there’s no denying, it’d be great to know with 100% certainty when the markets are going to sink or soar.

Unfortunately, my crystal ball is the shop.  And my Magic 8 Ball keeps telling me to “Try Again Later”.

So the next best thing we can rely on to predict the future is leading economic indicators.

Leading indicators are designed to predict economic activity six to nine months down the road.

They include things like consumer sentiment, initial jobless claims, manufacturers’ new orders, and interest rate spreads, just to name a few.

Monitoring the leading economic indicators is the best way to gauge where the economy is heading.

One I keep a close eye on is the Weekly Leading Index (WLI).  It’s published every Friday by the Economic Cycle Research Institute (ECRI).

The WLI combines a number of leading indicators into an easy to use WLI level and growth rate.

ECRI has a long track record of forecasting turning points in the business cycle.  In fact, they predicted the April economic slowdown six months early.

Without going into too much detail, when you look at the WLI, you should look for trend changes.

Like last October when the growth rate began to contract after growing for seven months.  It was projecting economic growth would begin to slow in six months.  And that’s exactly what happened.

But here’s the key.

The WLI isn’t forecasting a double dip recession.  In fact, it’s held steady the last two months.  And most recently, it registered its highest reading in 14 weeks.

It looks like another trend change is happening in the WLI right now.  But this time it is predicting economic growth will begin to accelerate in the next six months.

It’s telling me now is the time to buy cyclical sectors.  These areas will benefit the most from stronger economic growth.

Now let’s dig into this month’s trades, one in technology and the other in transportation.


The results are in…

Businesses have their head in the clouds.  But that’s not to say they’re flighty.

No.  I’m talking about the cloud computing revolution in the software business.

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:  Driving 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, they’re focused on improving productivity to boost the bottom line.

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

And thanks to the cloud computing revolution, the costs and time to implement new technology are shrinking.  Now companies are able to rapidly deploy and reap the profits from new technology… virtually overnight.

The low cost of implementing new cloud computing solutions has made them very popular with companies of all sizes.  From a cash flow and scalability solution, this is a great business move.

This 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 a rapid adoption of cloud computing solutions.

And the best part is cloud computing is still new.  As more companies shift to cloud computing, the software companies providing the solutions will see sales improve and their stock will continue to rocket higher.

A great way to profit from the cloud computing revolution is with the iShares S&P North American Technology-Software Index Fund (IGV).

Fundamentals:  A closer look at IGV

IGV holds 51 of the top U.S. based software firms.

The expense ratio is 0.48%.

The top five holdings and percentage weight for IGV are –

Company Name Ticker % Weight
Adobe Systems ADBE 8.67%
Oracle ORCL 7.46%
Microsoft MSFT 7.39%
Intuit INTU 7.08%
Citrix Systems CTXS 6.25%

Many of IGV’s holdings recently reported better than expected quarterly earnings and revenue.  It’s shown skeptical investors that companies will continue to spend money on productivity boosting software… even when they’re being tightfisted with their cash.

Technicals:  The charts lead the way

IGV has taken on a leadership role in the markets.  It’s rocketed up 13% since the beginning of September.

IGV is showing good relative strength to other areas of technology as well as the broad market.  Obvious relative strength of this magnitude can only be caused by one thing… institutional investing.

Right now the big money players are pouring money into software companies.

Just take a look at this chart…


You can see IGV recently broke through resistance of the April high.  And it did it without even batting an eye.

That’s a great sign this breakout has staying power.

Trade Alert

Buy:  iShares S&P North American Tech – Software Index Fund (IGV) up to $55.00
Recent Price:  $53.36
Price Target:  $65.00
Stop Loss:  $47.00

Remember:  IGV has recently broken out to a new 52-week high.  And judging by the volume and relative strength, it looks like institutional investors are rotating into the software industry.  But the rally is looking a little overbought.  You might consider waiting for a pullback to around $51.25 (the April high) to buy.  But just be aware this rally is strong and might continue straight on up from here.


The airline industry is an essential part of modern life.  Could you imagine what life would be like without it?

It’s played a starring role in globalization by aiding economic growth, world trade, international investment and tourism.

And after merely surviving through the Great Recession of 2008, airlines are now poised to rake in serious profits.

Macro/Economic Trend:  Travel Rebound

Consider this… The International Air Transport Association (IATA) just tripled their 2010 airline industry profit forecast.

The IATA is now projecting industry profits will hit $8.9 billion this year.  That’s up from the $2.5 billion it forecast in June.

Clearly travelers are taking to the sky much more than anybody predicted.

In fact, demand has improved so much recently traffic is now 3% to 4% above pre-recession levels.  And revenue is projected to hit $560 billion this year.

Here’s the kicker…

Demand is growing at 11% per year.  But capacity is only expanding at 7% per year.

It’s Economics 101… Supply and Demand.

Right now demand is outpacing the supply.  That’s great news for airlines.  It gives them pricing power in this ultra-price sensitive industry.  And it’s also leading to fuller flights.

It’s allowed the airline industry to expand their razor thin profit margins from 4.5% to 7.3%.

And to top it off, oil prices are stable.  So fuel costs aren’t putting the squeeze on margins.

The best part is investors are still worried about a slowdown next year.  They think this year could be “as good as it gets”.  So the bar is already set pretty low.

The way I see it, there’s still plenty of upside for airlines as the economy grows stronger.  The Claymore/NYSE Arca Airline ETF (FAA) gives a pure play on the upside in the airline industry.

Fundamentals:  A closer look at FAA

FAA holds stock in 24 airline companies worldwide.

The expense ratio is 0.65%.

The top five holdings and percentage weight for FAA are –

Company Name Ticker % Weight
Delta Airlines DAL 15.75%
UAL Corp UAUA 15.45%
Southwest Airlines LUV 15.08%
Deutsche Lufthansa LHA 4.43%
Singapore Airlines SIA 4.32%

FAA has a PE of 9x, which is significantly lower than the S&P 500 whose PE stands at 14.8x.

And the average market capitalization of the holdings is $4 billion.

Technicals:  The charts lead the way

FAA has been consolidating in a symmetrical triangle pattern.

Take a look at the chart below.  You can see it’s setting a series of lower highs and higher lows.


This pattern is clearly a sign of investor indecision.

But with the improvement in industry profitability, the odds now favor a breakout to the upside.

Trade Alert

Buy:  Claymore/NYSE Arca Airline ETF (FAA) up to $36.50
Recent Price:  $35.43
Price Target:  $42.50
Stop Loss:  $30.00

Remember:  FAA has been in a five month consolidation pattern.  But it’s still in a long term uptrend.  Once FAA clears resistance around $36, it should be clear for takeoff.


Consumer Discretionary (+6.5%)

Consumer discretionary stocks have turned the corner.

They’re now up nearly 9% in the last two months.  Clearly there are still headwinds from unemployment.  But with the evidence mounting for continued economic growth, the cyclical consumer discretionary stocks should continue to outperform.

Our position in iShares Dow Jones U.S. Consumer Services Sector Index Fund(IYC) is building momentum.  We’re quickly approaching our buy up to price.  So go ahead and buy IYC up to $61 if you haven’t already.

Clearly, the reinstatement of extended unemployment benefits sparked consumer spending.  It wasn’t a coincidence consumer spending fell dramatically when these benefits lapsed.  And with the government committed to providing unemployment benefits until new jobs are created, consumer spending should continue to grow.

Consumer Staples (+2.8%)

It’s the same old story for consumer staples.  They continue down their slow and steady path.  There’s still a premium on staples compares to their historic valuations. And the upside is limited.

Unfortunately, I just don’t see any catalysts for the sector.  I’m steering clear for now.

Energy (+1.0%)

Energy stocks are holding steady along with oil.  Oil’s trading smack dab in the middle of its trading range, around $75 per barrel.  But as the economy improves, demand for energy and oil should push prices higher.

Our Dow Jones U.S. Oil Equipment & Services Index Fund (IEZ) tracks the price of oil closely.  So once the economy picks up steam, IEZ should really rock and roll.  Hold tight for bigger gains ahead.

Financials (+3.8%)

Financials are turning the corner after lagging the markets since April.

However, talk of banks being forced to buy back billions of dollars worth of bad loans they sold to Fannie Mae and Freddie Mac has tempered any investor enthusiasm.  But the underlying theme of improving economic growth should provide a boost to the sector.

Our SPDR KBW Bank ETF (KBE) is just below our buy up to price.  So 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) just broke out to a new high on Monday.  We’re now up more than 12%.  But I’m expecting REITs to continue higher from here.  So hold tight for further gains.

Healthcare (+2.9%)

Healthcare stocks turned in a solid month.

Gains in the drug and biotech industries continue to be the bright spot in the sector.

Our iShares Dow Jones U.S. Pharmaceuticals Index Fund (IHE) and First Trust Biotechnology Index Fund (FBT) are both breaking out to new highs.  IHE is up 10% and FBT is now up 9%.

We’ve clearly got the strongest industries in this sector covered.  Hold tight for further gains.

Industrials (+4.4%)

Industrials have put together solid back to back monthly gains.  All together they’ve surged more than 9% in two months.

Our rail car loadings indicator continues to show growing economic activity.

Now, our Dow Jones Transportation Index Fund (IYT) is bumping up against resistance from the June and August highs.  Right now we’re sitting on an 8% gain. But there’s still plenty of upside, hold tight for now.

This month we’re also adding the Claymore/NYSE Arca Airline ETF (FAA)… See Trade Alert 2 for more details.

Technology (+6.1%)

Tech stocks are resuming their leadership role this month.  That’s great news for the overall health of the market and the economy.  The bottom line is technology stocks should lead the market higher in a healthy economy.

Strong earnings in the software industry have sparked investor interest.  We’re addingiShares S&P North American Technology-Software Index Fund (IGV) to ride this wave… See Trade Alert 1 for more details.

Our SPDR S&P SEMICONDUCTOR ETF (XSD) is clawing its way back.  In fact, it has surged more than 9% higher so far in September.  I think the selloff in semiconductors was overblown.  Now we’re seeing them regain ground quickly.  Hold tight for now.

Materials (+4.6%)

Materials stocks added to their recent gains again this month.

The gold miners have done their part to bolster returns as gold reached record highs of more than $1,283 per ounce.

And we’re even seeing the big chemical companies like DuPont (DD) breaking out to new 52-week highs.

But as always, the materials market hinges on how much China can consume.  The good news is… Chinese imports jumped 35.2% this month.

As long as China continues to increase imports, materials stocks should continue their solid run.

Utilities (+0.5%)

Utilities have leveled off near their 52-week highs.

But the longer interest rates stay low, the more attractive the 4.1% yield on ourUtilities Select Sector SPDR Fund (XLU) looks.

Right now the spread between XLU’s yield and the 10-year Treasury is near record highs.  If this spread narrows to its historical average, XLU could double.  Continue holding XLU for the next leg higher.

Portfolio Changes

  • This month we’re buying IGV and FAA…
  • Move IEZ from Buy to Hold
  • Move XSD from Buy to Hold


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