Archive for June 2009
Most investors will be asking, “well what should I do with my money?” During the summer there are still opportunities – you just have to be more selective.
For short-term investors there is the Independence Day Trade that occurs from two market days before the end of June to five market days after Independence Day. For sector investors there are a number of possibilities throughout the summer. I will comment briefly on some of the opportunities, including gold and oil.
The biotech sector is often thought of as the poor cousin to the technology sector. Investors turn their interest to biotech when they want to be more speculative but do not want to invest in technology stocks.
Biotech stocks tend to outperform the S&P 500 from June 25th to September 13th. From 1992 – 2008, biotech stocks (XBI – SPDR Biotech ETF) beat the S&P 500 14 out of 16 times and had an average gain of 13.5%. During this time period the S&P 500 had an average gain of 0.1%.
The chart below shows that the biotech sector is lining up for a good trade once again. The sector is currently at long term support and has just broken through the 50 dma. The trades for the last three years are shown with green arrows for a buy and red arrows for a sell. Interestingly, despite the poor performance of almost every sector last year during the summer, biotech produced a healthy positive return.
The biotech sector tends to go up from the end of June until the mid-September because investors stake a position ahead of the autumn conferences that tend to provide a positive outlook in the industry. Positive returns in this sector would definitely be good medication in the current market.
The S&P 500 currently sits at 919 slightly below the resistance line of 930-940, a level that we have been at several times before. It is possible that a bit of work will be required to get through this point. We are also just below the 200 day moving average, which will also provide some resistance. If the market does breakthrough, on good volume, the resistance line and the 200 day moving average, then this would be short-term bullish and it is possible to see the S&P 500 run to 1,000 over the next two months. At this time, a turn-back at resistance is the favoured scenario.
Interestingly, the market might be forming a reverse head and shoulders pattern. It is too early to tell if this bearish pattern will be fulfilled. If the market gets turned back at the resistance point on strong volume, then the probable scenario would be for the market to hit the left shoulder (LS) November level of 752.
The Canadian market has recently outperformed the U.S. market on the strength of commodities. The commodity matrix is a levered play on global improvement in economic conditions. If the global economy is expanding, investors should expect the Canadian market to outperform. If the global economy is contracting, investors should expect the Canadian market to perform poorly.
Mirroring investor’s expectation of better times ahead in the near future, is the expectation of higher oil prices. Demand is only part of the equation for oil prices. As it has become a hot commodity in the last few years, other than the last half of 2008, it has been speculators and hedge funds that have pushed the price up. Typically, oil trades at its marginal cost of production over the long-term. I would not use this as an entry or exit point in a trading strategy, but it helps to establish if oil is over-valued or under-valued. Currently the marginal cost estimates are approximately $60-70 bbl. In May of last year I was recommending investors take their profits (based upon seasonal strength) at $135 a barrel. People seemed surprised at my recommendation because the consensus at the time was that oil could go much higher. The rest is history as oil crashed to the $40 range.
What should we expect for price of oil to be in the near future? It is important to realize that we have finished one of the strongest seasonal trends of the price of oil increasing up to the beginning of May. Oil stocks (XOI) have increased 24 out of 26 times from February 25th to May 9th. From a seasonal point of view oil can increase or decrease at this time, but its movements are random and it is typically not a good time to place an oil trade.
Just like investors pushing up the market anticipating an economic recovery, investors are pushing up oil prices on the same expectation. Taking a long position on the oil sector is a very risky proposition at this time because of the leverage being applied to expectations. The price of oil has gone up substantially, but yet demand has not increased. In fact demand has decreased and there is so much oil out there that there are plenty of tankers full of the stuff, tied up and being used for storage. In addition hedge funds and oil companies have been taking advantage of the contango trade. Instead of selling the oil today they are storing the oil and sell it forward for delivery at a future date. With the dynamics in the marketplace, it is possible that if the current trends continue, there will be no more storage space for oil in four to six weeks.
Sometimes betting on a large improvement in the future can be a wise trade, but you have to know the price that you are paying. Given that at this point, oil is extremely levered to a strong economic recovery, there is a lot of downside risk if the economy does not expand as expected. In my books, on a risk-reward basis, a long position in the energy sector at this time is not wise.
Like children on a car journey asking if they are almost “there,” investors are asking, are we at the bottom, are we at the bottom of the bear market?
It might be wishful thinking to expect the good times have arrived again. Currently, investors are trying to outsmart the market by getting into the market before the recession ends. The conventional wisdom is that the stock market bottoms six to nine months before the economy. Given that the market often makes huge gains bouncing off the bottom – the “smart thing” to do is to get into the market before everyone else. The big question stands: are investors being smart, or are they being overly optimistic and wishing for a recovery.
If we step back a few months to the beginning of March, investors were wondering if the financial system would fail and the world was coming to an end. The market became very much oversold. Things changed fast and the market rocketed upwards. Two things happened. First, some of the reports coming out of the financial system seemed to be turning around from being very dire to showing signs of hope. Investors started to come to the realization that the Obama administration would not let the financial system collapse. Second, there were some “green shoots” of economic data that were warmly welcomed after so many months of negative data. The media loves to coin terms. It seemed that every bull in the market was talking about green shoots and the end of the recession. It led me to ask the question, “is everyone was now a farmer.“
Are things really as positive as everyone is assuming? Not really. With some positive numbers from the financial system all of a sudden everyone is assuming that the crisis is over. There is no question that the situation has gotten better: the credit freeze has thawed (at the LIBOR level) and the big banks appear less prone to going bankrupt. Scratch below the surface of the bank results and the numbers are not as good as they appear. Overall, they are really not making money at their core business lending. Their ratios have been bolstered by cash from the government and a large part of their profits have been generated from their trading desks. There is one additional problem looming on the horizon for the banks – credit card debt. So far this debt has been manageable, but a lot of consumers have been leveraging their existence with credit cards. This trend is unsustainable. If the economy continues to slide, watch for this situation to get worse and banks to start increasing their loan loss provisions (LLP).
If we examine the overall economic data, it is not good. Although we had a couple of positive numbers that surprised to the upside, such as retail, in major economic downturns, there are always transitory positive results. Investors are often anxious and want to declare the recession over. The first few signs of positive relief investors rush back into the market, expecting a sustainable positive uptrend. Overall the numbers coming in are still bad: Japan’s exports were down 39% in April, U.S. house prices down 19% (and still going down), U.S. unemployment at 8.9%, Japan Real GDP YoY – 9.7%, UK GDP – 4.1%, U.S. GDP -2.5% etc.
One or two cars do not make a parade. Do not be fooled.