Understanding the Market Cycle (And Where We Are Now)
Stockscores.com Perspectives for the week ending June 5, 2011
In this week's issue:
I encourage investors to inspect the charts of sector ETFs each week. Doing so provides insight in to where money is flowing, allowing us to play individual stocks in strong sectors. An overall analysis of the sectors also tells us a lot about what stage of the business cycle we are in and how far the market is from a top or bottom.
Consider what we know about this market and what has happened over the past couple of years. After the sharp sell off that took stocks down to their lows in March of 2009, we have seen pretty good gains in stocks. However, not all stocks have done well and some sectors of the market have done better than others.
The leaders early in the bull market were mining stocks, led by the Gold mining companies. Gold has gone up well largely because the US Dollar has declined and governments have run huge deficits. The fear of default by governments has led people to buy Gold as a safe haven.
While we have seen the stock market do well over the past two years, not too many people feel like the economy is performing well. Unemployment remains high and there is a general feeling of uncertainty. The economy is better than it was, but it still has a long way to go before people feel good about the financial world.
A good indicator of global economic strength is Copper, which is used in so much industry. There is a Copper ETF trading with the symbol CU that has been stuck in a sideways trading range for all of 2011 after a good bounce back in 2010. I think it summarizes well how the economy has done over the past two years. First we had a bounce back from fear where we started to feel better about the economy but this year, we feel like the economy is just hanging in there without making any great leaps forward.
The Exchange Traded Fund TLT is a good way to track the US bond market which provides a good clue about where the economy is in its business cycle. A steep yield curve means that borrowing money in the short term (5 years or less) has a low interest rate compared to money borrowed for longer terms (like 20 years or more). A steep yield curve is typical in the early stages of economic recovery as there is little demand for borrowed money, making short term interest rates low. This is what we saw last year; anyone who looked to get a mortgage will know that the spread between long and short term interest rates were quite wide.
The TLT shows us how long term interest rates are performing, if you look at this chart you will see that the price trend stopped going down in late February of this year and has been moving higher since. If bond prices are going up, yields are going down, making it cheaper to borrow money. Since the TLT looks like it will continue to move higher, we can say that the yield curve is beginning to flatten, that is a sign that we are in the early stages of economic expansion.
In early stages of economic expansion, Energy, Consumer Services and Capital Goods sectors begin to do well. This means we will see money move out of the mining sectors which were leaders early in the bull market and in to these other sectors. As we come out of the pull back phase that the market is in right now, expect that there will be new sectors taking the leadership role away from the mining stocks.
This puts us at about mid cycle in the bull market trend. While traders may feel like this market has been frustrating over the past 5 weeks, remember that pull backs in long term bull markets are normal. We went through the same thing at this time last year before a good run in July, a slow August and a resumption of the upward trend at the end of September.
Is the bull market over? Based on the rotation of sector strength, no. Sectors like Financials and Consumer Discretionaries tend to do well at the late stages of the bull market and those sectors are still laggards in this market cycle. Stick with a bullish market outlook but expect that new sectors will take the leadership role as we go in to the Fall.
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Generally speaking, I think investors should be mostly in cash right now. The market has been in a pull back phase over the past 5 weeks and is not yet showing signs that it will end that profit taking. What is happening now is very similar to what happened last year at this time. After a sell off that began in May, prices went sideways through June to August with a good rally in July. The bull market resumed its upward trend late in September.
During the summer, once the market has stabilized, we will be able to find select stocks to do well provided we uphold a high standard of what trades we take. The big challenge is to not take marginal trades out of boredom. This is the season to be defensive.
This week, I did a very simple Market Scan on Stockscores.com, looking for stocks listed on the Canadian market with a Sentiment Stockscore of at least 60 and which traded at least 2500 times a day. This revealed only 16 stocks, here is the list with my comments on each chart. Take a look at the charts and compare my comment with your read of the charts:
T.WIN (Wi LAN Inc) - has been in a longterm upward trend with some strong steps higher over the past year. The stock has just made another sharp step higher in the last two weeks, I expect the stock will now trade sideways and work its way back to the upward trend line. Risky entering here but a good hold if you have it.
T.YRI (Yamana Gold Inc) - is locked in a sideways trading range, this stock is a parking lot right now and will continue to be so until it can break through $13. If it does make that break then it can rally up to resistance at $15, making the upside potential relatively small for the risk. Not looking like a good trade right now.
T.ATH (Athabasca Oil Sands Corp) - has been climbing higher since last fall but with a lot of volatility, that means the market likes it but is uncertain about the company. That makes the stock a hard one to trade as it is difficult to predict. Worth considering on breaks of weakness.
T.HSE (Husky Energy Inc) - Husky is working on a turnaround after being an underperformer for some time. The downward trend line was broken early this year and the stock is slowly building optimism. Still no trade here but a break through $30 with good volume support would be a positive sign.
T.ENB (Enbridge Inc) - a solid steady gainer, probably the best performing of the liquid Canadian stocks. Worth considering on a pull back to the upward trend line, but don't chase it higher.
T.BAM.A (Brookfield Asset Management Inc) - has made good gains over the past few years but with much more volatility along the way than a stock like Enbridge. This year, the stock has been relatively boring but it is showing signs that it could start another upward leg in the long term upward trend. Worth considering for a conservative investor with patience.
T.ECA (EnCana Corporation) - has been dead money for a long time, although it does pay a yield of about 2.5%. This year has seen the stock slowly build optimism as shown by the rising bottoms through 2011. Still needs to break through $35, if that happens, could be worth considering.
T.RCI.B (Rogers Communications Inc) - recently broke from a head and shoulder bottom pattern, a good sign that it will try to move back to its old highs. The stock is going to find resistance at around $41 so there is not a lot of upside, but a good hold if you own it.
T.BCE (BCE Inc) - a very good performer through May as investors looked for a safe place to put capital. The stock is now at the top of its long term upward channel which means it will find some selling pressure that will limit its short term upside. Probably more likely to pull back in the short term, I think it is a stock worth considering on a pull back to the long term upward trend line.
T.TRP (TransCanada Corporation) - the trend for this stock has gone from being linear to a curve pointing higher. That means investors are chasing it higher with the risk of paying too much because of emotion. Worth considering on weakness that takes it back to the 2 year upward trend line.
T.CPG (Crescent Point Energy Corp) - has been trending higher for two years but with so much price volatility that makes it difficult to predict where the stock will go in the short term. While it is a strong stock, the unpredictability makes it one best avoided.
T.VRX (Valeant Pharmaceuticals International Inc) - a very strong stock in a strong sector, this stock is more appropriate for swing traders who can play close attention to it. A break through $52.50 is a positive, but the gains over the past year and a half make it risky.
T.MEG (MEG Energy Corp) - the best looking chart of this group, the stock broke through $50 resistance this past week and looks like it wants to continue higher.
T.BNS (Bank of Nova Scotia) - the stock is in a good long term upward trend but will probably spend the near term going sideways as it comes back to the long term upward trend line.
T.CNR (Canadian National Railway Company) - in a steady, linear upward trend, this is a good stock to consider on pull backs to its upward trend line. A good hold if you own it.
T.NA (National Bank of Canada) - another strong performing stock over the long term, weakness over the past two weeks has taken the stock back to its upward trend line so it should bounce back next week and continue higher.
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1. T.MEG
T.MEG has pretty good potential here as it is breaking out of a period of sideways trading this week, moving to new highs.
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2. T.NA
T.NA is a stock in a strong and orderly upward trend which should resume soon as it has now pulled back to its long term upward trend line.
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References
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Disclaimer
This is not an investment advisory, and should not be used to make
investment decisions. Information in Stockscores Perspectives is often
opinionated and should be considered for information purposes only. No
stock exchange anywhere has approved or disapproved of the information
contained herein. There is no express or implied solicitation to buy or
sell securities. The writers and editors of Perspectives may have positions
in the stocks discussed above and may trade in the stocks mentioned. Don't
consider buying or selling any stock without conducting your own due diligence.
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