The Market Newsletter Blog

On April 20, BP’s offshore platform exploded and caught fire, causing a major oil spill.
Senators from California, Oregon and Washington introduced legislation to ban oil drilling off the West Coast amid mounting concern about the spill in the Gulf of Mexico.
Clearly offshore drilling is too dirty and too dangerous and it needs to be strictly regulated, with that said, can we afford to stop it? of course not.
At this point in time we don’t have better and cheaper alternatives available, the truth is that we are still decades away from implementing it (coal, nuclear power, renewable fuels, etc.) and the American people understand it, a recent Pew Research Center for the People and the Press poll (a National poll) found that a majority- 54%- still favored it.
The US trade deficit rose to a 15 month high as rising oil prices pushed crude oil imports to the highest levels since the fall of 2008. The larger deficit is evidence of a rebounding US economy.
Energy independence is highly concerned with oil; offshore drilling is necessary to the U.S. energy independence efforts and to the goal of reducing the U.S. imports of oil.

Stocks rolled over in the final hour of trading, sunk by disappointing earnings results from retailers Kohl’s (KSS -5.8%) and Urban Outfitters (URBN -6.7%) and the start of the broader crackdown on Wall Street firms traders had feared. Decliners topped advancers on the NYSE by 2 to 1.

For more than a year, the stock market indices like S&P 500 (SPY) and Dow Jones (DIA) have been enjoying a nice run driven by massive government spending around the world and a very dovish Federal Reserve that has kept interest rates close to zero until today. In the last 2 months, the rally was even stronger with the Dow and Nasdaq closing higher for 8 straight weeks.

Nasdaq Chart

So why do I think that now is the time to be selling US stocks and accumulate cash?

Just the fact that we had eight up weeks in a row is usually a reason for professional money managers to take some off the table. Add to that the market is now up 80% from its March lows and there haven’t been any 10% correction since. Another technical indicator I look at is the Investor sentiment survey that is now showing the number of bears is less than 20% which usually points to a correction coming soon. Volatility has also made new lows and the Put/Call ratio has been moving lower showing a lot of complacency.

On the Fundamental side, the credit problems in Europe are growing and things are deteriorating quickly. There are now estimates that Greece by itself needs a $100B package to fix its issues. And then there is Spain, Portugal, Italy, and Ireland. There is no way that weakness in Europe doesn’t affect our US Economy.

Another major factor that might affect the markets here in the US is the Federal Reserve. Even though they have kept a lid on interest rates so far, they will heve to tighten the monetary policy at some point in the next few months. Inflation is starting to show up in indicators like the PPI and commodity prices. Higher interest rates will definitely impact the US GDP and will hurt the economy.

Gold Chart

Most of the refining industry stocks have been hammered in the last two years since the Great Recession started, and they didn’t even participate in this past year’s way up, in which the S&P (SPY) rose around 60%. Valero (VLO), for example, is down more than 70% from its peak and Tesoro (TSO) is down 75%. However, we feel that all this is about to change and that these stocks are about to go much higher. Why?

The first reason is the seasonality of the refining business. We are now entering the strongest period in which demand for gasoline picks up through the summer. As more and more people start traveling, they consume more gas and the refiners can start raising their prices. You can see from the crack spread chart below that this started happening already, as the spread has doubled from 6 to 12 in the last few weeks.

The second reason is that oil is breaking out to new highs. On Friday, Nymex crude closed at $81.5. The global demand for oil is still strong, especially in India and China. China has also confirmed that it is planning to keep buying commodities, at least for the time being. The OPEC countries are also supporting higher oil prices cause they want to lift their economies and avoid any problems for their own people.

The third and more important reason is that the recovery in the US is getting stronger and the consumer has started spending more and more. For the first time on Friday, consumer debt has started rising again. That means that consumers are now willing to put more debt on their credit cards and they will definitely be spending more money on gas. It might be bad for the future (since our problems originated because of more debt!) but for now the government wants to see people reloading their credit cards.

In the last few days, many of the refining stocks rose substantially and if we get a pullback in the coming days, we’ll definitely add to our positions. Our two favorite stocks are VLO and TSO.

We got stopped out on our attempt to short the market a couple of weeks ago. So now, we are flat and have no short or long positions. However, the recent rally has been on very light volume and the S&P 500 has not been able to close above 1100. Since we have been stopped out, we will wait to see more signs of professional selling before we can attempt to short again. We definitely don’t want to trade on the long side for now.

It seems that the correction has finally started. With the selling that we saw today, the bears will be back in force and will try to push the market further down. Recently, the sentiment on Wall Street has become very bullish, and that is the part that was missing for the correction to start..

The ability to read stock charts can help a lot in making sound investment decisions as it not only gives a snapshot of a stock past performance, but also helps predict the future direction. In this article, we summarize the most reliable chart patterns used by investment professionals.

The most reliable bullish chart patterns:

- Cup with Handle: The cup is in the shape of a ‘U’ and the handle has a slight downward drift. The right-hand side of the pattern should have a low trading volume. It can be as short as seven weeks and as long as one year. As the stock comes back up to test the old highs, Investors who bought at or near the old high will start selling the stock to break even. This selling pressure will make the stock price trade sideways with a tendency towards a downtrend for four days to four weeks, then it takes off and takes out the old highs.
- Double Bottom: This pattern describes the drop of a stock, a rebound, another drop to the same level as the original drop, and finally another rebound that goes higher than the previous highs.
- Pennant: It is formed when there is a large movement in a stock, followed by a consolidation period with converging trendlines, followed by a breakout movement in the same direction as the initial large movement.
- Inverse Head & Shoulders: This happens when the price falls to a trough and then rises again. The price falls below the former trough and then rises again. Finally, the price falls again, but not as far as the second trough. Once the final trough is made, the price heads upward toward the resistance found near the top of the previous troughs. The first and third trough are considered shoulders, and the second peak forms the head.

The most reliable bearish chart patterns:

- Head & Shoulders: This happens when the stock rises to a peak and subsequently declines, then the price rises above the former peak and again declines, and finally, rises again but not to the second peak and declines once more. The first and third peaks are shoulders, and the second peak forms the head.
- Double Top: This pattern describes the rise of a stock, a drop, another rise to the same level as the original rise, and finally another drop. The double top looks like the letter ‘M’. The twice touched high is considered a resistance level.
- Rounded Top: A rounded top, which looks like an inverse ‘U’, may form at the end of an extended upward trend and indicates a reversal in the long-term price movement. The initial upwards trend becomes exhausted as the demand for the stock dries up. The reversal to the downward slope of the rounding top indicates that demand has tapered off and a surplus supply is present, basically there are more sellers than buyers.
- Pennant: It is formed when there is a large movement in a stock, followed by a consolidation period with converging trendlines, followed by a breakout movement in the same direction as the initial large movement.

Since the market correction started in November 2007, Tech stocks have been hit really hard as investors sold everything they own, the good and the bad. The Nasdaq composite was down about 25% when it hit bottom a month ago, while the S&P 500 was down about 20%. If you look at the market leaders before the correction, GOOG and AAPL were both down more than 40% from their October highs.

The reason behind selling tech stocks was that the financial crisis will lead to slower IT spending by the Banks and Brokers, and a consumer led recession will result in slower tech sales. Six months later, those same big tech companies reported earnings for the first quarter and they easily beat wall street expectations. So why were analysts estimates so low for the tech sector?

In GOOG case, revenues for the first quarter were 42% higher than a year ago, and they beat analysts earnings expectations by 7%. It turned out that the data on paid clicks that all analysts base their numbers on was seriously flawed and they all blamed their bad estimates on the firm that provides these statistics. As for AAPL, revenues were also around 43% higher, and earnings beat expectations by 8.4%. It was the incredible number of Mac computers sold that boosted AAPL revenues. Analysts realized that even during a recession people are willing to spend some money to get AAPL’s cool products. Both companies also benefited from strong international sales.
Even if you look at other big cap tech names like IBM or AMZN, they reported very strong numbers that nobody on the street was expecting. Some of them even guided higher for the remainder of the year. But can these growth rates be maintained in the foreseeable future? Well, if with all the problems that hit the US economy in the first three month of the year they can report such numbers, it is highly unlikely that things will slow down in the second half when it is seasonally the best time for tech companies to sell their products. In addition, the US economy is now supposed to be getting better with all the Fed and Government bailout plans.

In addition to looking at the fundamentals, we also like to check the Technicals. Both GOOG and AAPL broke out from sound bases and are now back above their 50-day moving average.

GOOG broke out and gapped higher on strong volume the day after releasing its earnings report. Its relative strength is making new highs already. This is very bullish for the stock going forward. You can also look at the QQQQ chart which tracks the Nasdaq 100 index to get a more general picture. It bottomed at around $41 in March and is now trading at $47, around 15% higher. RSI is also making new highs.

Given both strong fundamentals and technicals, we believe that the Tech sector will outperform the overall markets for the remainder of the year and will be leading the markets higher going forward. If you would like to take advantage of these moves without being exposed to only one specific stock, you can invest in the QQQQ (Nasdaq 100) ETF, or if you can handle more risk you can buy QLD. With the recent run up of all the stocks mentioned here, you might want to wait for a pullback before investing your money.

Gold prices have been rising sharply over the last few months while the equity markets went into a sharp correction. Over a one year period the popular GLD (Gold ETF) is up almost 40%. Compare that to the S&P 500 or SPY which is down 10% during the same period. The main reasons for the rise were basically Inflation and the weak dollar. The explosive growth in emerging markets over the last few years has led to a huge commodities bull run and fueled global inflation, which in turn put pressure and weakened the USD against most of the major currencies. And then to make things worse, a nasty credit crisis hit Wall Street last fall due to the collapse of the mortgage subprime market. The Federal Reserve, in order to avert a complete collapse of the financial system, had to start slashing rates and add liquidity to the system. Interest rates went down from 5.25% to 3% in a few weeks. That’s when Gold prices had their steepest rise, going up 300 points since November.

So why do we think you should sell Gold and specially the mining stocks if prices are so strong?

First, if you look at the mining stocks prices compared to the gold prices, while the GLD is up 40%, the mining stocks ETF, or GDX, is up only 20% over a one year period. The reason for the underperformance is that it is getting harder and harder to extract the metal from the ground and also more expensive. The margins for mining companies are not as good as they used to be.

Second, and more importantly, the 2 main reasons behind Gold rise may not be valid anymore, at least in the short term. At the last Fed meeting, interest rates were cut by 75 basis points to 2.25%. When that happened gold prices unexpectedly collapsed 100 dollars in 3 days. The reason was that investors in the metal were disappointed and the markets were actually looking for a 100 basis points cut. The fed’s next meeting comes in April and this time traders are expecting a 50 basis point cut. However, we think it is very likely that the Fed will only cut by 25 basis points and that might disappoint investors again. Even if the Fed cuts by 50 basis points, and rates go down to 1.75%, that might be the last time we even get a cut. Very few people are expecting rates to go lower than 1.75%. The ECB, on the other hand, is expected to just start cutting rates later this year when the EU economy shows more signs of weakness. All that could stabilize the dollar in the coming months.
As for inflation, the numbers are finally starting to moderate due to the weakness in the world economies led by the US housing crisis. The PCE inflation numbers just released show inflation for the last year at 2% which is still inside the Fed’s comfort zone. Actually the Fed has been predicting inflation to moderate for some time now but no one on Wall Street really believes them.

Finally if you look closely at the GLD chart, you can see that the short term uptrend has been broken. For the first time since Gold broke out last year, it has fell through its 10-week moving average and it has done so on high volume in the last week. This surely is another sign of weakness.

Gold might still be in a long term bull market, but for all the reasons mentioned above, it is now due for a correction in the short term.

Since the financial crisis started last Fall, the primary concern of the FED was to avoid a complete collapse of the banking system. By creating new ways of providing liquidity through Term Auction Facilities (TAF), together with reducing rates, they surely prevented that from happening so far. However they also pumped hundereds of billions of dollars into our economy (in addition to the government stimulus plan).

So who will benefit the most from this liquidity?

It is the financial services companies themselves who will be the biggest winners from this. The Fed has opened the door not only to commercial banks but also to investment banks who would like to borrow money and get these mortgage backed securities off their balance sheet. This is a tremendous amount of money that will be funneled to the Financial institutions before making its way to the other sectors of the economy.
What we have seen previously, when the Fed adds liquidity to the system, it usually takes about 6 to 12 months for its impact to surface in the corporate earning reports. So basically, we might just be seeing the bottom for a lot of the financial institutions at this moment.

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