JS Trading Notes

While several internal technical indicators suggest caution for the intermediate-term in the stock market several facts paint bullish picture for the multi-month time-frame. One positive is the out-performance of bank stocks since December 2011.

Typically, the action in banks and financials lead the market. The rationale is that banks provide the credit to keep the economy growing — when banks are lending and making money, the economy at large must be doing well.

Another sign the economy will hold up rests in the leading economic indicators.

The leading index moving into 2012 has been on an upswing. The yield curve also supports a good economic outlook.

Rarely does a severe bear market begin when banks are outperforming and both the yield curve is positive and the leading economic indicators point upward.

Lastly, the weekly MACD on the S&P 500 looks strong and suggests continued upward momentum over the medium term.

The bottom line: the medium-term outlook is cloudy since reliable technical indicators suggest weakness while other factors paint a more positive picture. For positive trading results, the focus should be on individual stocks and themes. There will be plenty of trading opportunities as the months unfold.
 
Carbo Ceramics (CRR) rose on heavy volume today off support near 52 week lows, clearing near-term resistance at 96.03. Short interest in the issue sits at 5.7 days. A director bought 2,000 shares a few days ago around 95. The unusual action today suggests a possible short-squeeze. I like the trade under 99 with an initial stop-loss at 93 and trailing stops thereafter set once daily below short-term support levels formed on the intraday chart.
 
After weeks of going straight up in the U.S. stock market, Tuesday’s break announced the beginning of a possible correction. A view of the NASDAQ chart, the leading major index in the market, provides some insight on the recent action.

As shown, the NASDAQ broke down from a tightening ascending wedge pattern and now appears to be retesting the lower side of that wedge. Another bout of selling within the next four days would confirm the break. A rise to new highs would negate the break. The set-up allows for a low risk index short with a stop at new highs. Instead of the NASDAQ index, I would short (or buy puts) on a lagging index ETF like the Spider Industrials (XLI) or Ishares Transports (IYT) and close the short if the NASDAQ or S&P500 hit new highs.
 
Where can you find a company with a P/E of 9, yield of 4%, growing earnings at over 70% yearly? The answer is in Canada's oil patch. Canyon Services Group (FRC.TO) provides drilling services for oil and gas companies extracting hydrocarbons from the massive shale beds located in Canada. A stock chart is available at my wordpress blog. This well-managed company, in the latest fiscal year, showed a 25% net margin and 30% return on equity. This is the cheapest growth stock I've seen in a long time.
 
While the U.S. stock market seems poised for a correction, some economically sensitive sectors of the market suggest any such correction may be mild. My attention is drawn to four areas: banking, retail, consumer discretionary, and residential construction. Strength in these areas suggests underlying strength in the economy and in the market itself. (See my blog at WordPress listed at the outset of this journal for charts that compare the four sectors to the S&P 500.)

In today’s trading, the market continues to churn near highs with decliners outnumbering advancers by almost 3:2. A lot of economic data hits the wires this week, including a fed meeting tomorrow. My current bias is that the market will see only a 2-4% correction at the most unless really bad news hits.
 
My inbox receives a lot of junk email promoting investment newsletters; most such email gets discarded without review. A recent piece caught my attention, perhaps because the claim seemed so bold -- $150+ oil by mid-year. The claim was backed-up by the writer's research showing that if oil prices fall to such low levels so as to make drilling new wells unprofitable (like at the end of 2008), for every week that the number of drilling rigs in operation remains below average (following the bottom in oil prices), it takes 2.5 weeks for that missing drilling capacity to come back on-line. In the case of the oil bear market which bottomed at the end of 2008, oil drilling remained below average for about a year thereafter, until the end of 2009. The key observation is that you can forecast the timing of a future peak in oil prices by multiplying that below-average drilling year by 2.5 and adding that time chunk to the beginning of 2010 to project a peak in oil prices by mid-year 2012, plus or minus three months. The rise and peak in oil prices arrives due to a predictable supply deficit. (See my blog at WordPress listed at the outset of this journal for a chart of light crude oil prices over the past five years.)

The bottom line --financial assets related to oil should outperform into mid-year 2012.
 
Apple (AAPL) looks overdone to the upside here. The stock is surging above its long-term channel and 10 week moving average lines. (See my blog at WordPress listed at the outset of this journal for an annotated chart of AAPL). I'm not advocating a short position, but new buys should be postponed. This run is starting to look like a final climax run for the climb in AAPL that began in 2009.
 
Expect another crash in the stock market.

With U.S. short-term interest rates near zero (now popularly called the zero lower bound), and yields on longer-term government paper at historical lows, savers and the growing population of retirees are looking for better places to park their capital than the safe but low yielding CDs, money-market funds, and saving accounts. So, seeking better returns, this enormous chunk of cash chases riskier assets (like stocks), rather slowly on the buy-side as the assets rise in value, and then quickly on the sell-side when the risky assets fall in value. The end result of this massive asset reallocation dance is enormous volatility and one-way markets: the assets go up in value with hardly a pause and then, as happens to all risky assets, they eventually go down, and all those risk-averse folks sell in a hurry, crashing the asset class.

This behavior is easily seen in stocks with the following 20-year chart illustrating the correlation between stock market volatility and interest rates on 10-year treasuries. (see chart at my WordPress blog -- the link is listed at the outset of this journal).

Historically, when the stock market (S&P500 Index) has rallied, shown by the rising blue lines in the lower chart, volatility had been positively correlated with the yield on 10-year treasuries — highlighted by the orange-circled areas above the rising blue lines (correlation above the zero line is positive correlation, under is negative). When the stock market went down (falling blue lines), volatility had been negatively correlated with the treasury yield (orange-circled areas above falling blue lines). Now that interest rates are at the zero lower bound, the historical relationship between volatility and yield no longer applies. Volatility exploded in late 2008, and the stock market has rallied since early 2009 while volatility has remained largely negatively correlated with treasury yields. What this means is that risk-averse money is chasing stocks and is avoiding the negative real interest rates on U.S. Treasuries.
 
Pepsico (PEP) disappointed investor's on February 9 with a slightly reduced earnings outlook and the stock lost 6% of its value over the following few weeks. The actual news was the company is cutting costs (headcount, product focus) to improve margins for the long-term, but the market knocked it down for the 2012 outlook. At these levels, Pepsico yields 3.2% and has a long history of regular dividend hikes. With its global franchise and strong cash flow, Pepsico is a reasonable value here. But I don't think buying Pepsico outright is the right play. Better is to sell a put contract on it. I like the July 21, 2012 with strike 62.5, currently selling for 1.41. If the stock closes above 62.5 on July 21, you keep the premium ($141 for each option contract). If it closes below 62.5, you get to own stock in a great franchise at a bargain basement price of 61.09, which is the adjusted cost basis (62.5-1.41). Every options contract sold represents 100 shares of stock. You can find more ideas at my blog on WordPress listed at the outset of this journal.
 
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