Write Your Own Investment Success Story
Thursday, July 9, 2009 | Bob De Dea
It's earnings season (again), as Alcoa (AA) got the party started last night by issuing the inaugural report of the season. With its numbers coming in better-than-expected, there is a sense of hope on Wall Street that there is money to be made in this market.
With the onslaught of reports set to arrive in earnest during the coming weeks, it's important to tune out the noise, broaden your focus and take a look beyond individual stocks to the strongest and weakest sectors.
Today we'll take a look at the recent performance of four sectors and examine how you can generate your own "seasons of earnings" in sectors ... oftentimes more frequently than every quarter!
In an article I wrote at the end of April, "2 Sectors Poised to Provide Serious Trading Profits," we took a look at the NYSE Bullish Percent Index charts for the steel-and-iron and restaurant sectors. They were in overbought territory and we were anticipating a fall.
We revisited these sectors again in mid-May in "'Steel' Yourself Against Becoming Bear Food." Back then, the steel-and-iron sector did a head fake and moved back up. Our stop-losses would have done their job and gotten us out of the trade with just a scratch.
Well, on June 22, Sector Hunter put in a 70% Sell Signal in the steel-and-iron sector, followed by the same signal in the restaurant sector on June 26. Below is Tuesday's Industry Bell Curve from Investors Intelligence. I've circled the current positions of the two sectors, right at that 70% mark.
'Feed Me, Seymour!'
Speaking of bears and food, let's take a look at the restaurant industry first.
Back in April, this sector was at 86.21% on the BPI, its highest level since 1999. By May, it had fallen to 74.14%. (Remember, Sector Hunter doesn't put in a sell signal till the 70% line is broached.) Here's where it was on Tuesday:
So, restaurants also gave us a quick turnaround (note the circled "O" in the third-from-last column, just before the stock went up), where we would have been stopped out, similar to the one in early 2004.
But it was too good to be true; the sector couldn't sustain its overbought status and reversed again on June 11 to start its downward tumble. If you got stopped out and waited for the second reversal below 80%, you would have turned a quick profit.
Since the June 26 Sector Hunter alert, the sector has continued to move down and can still be a viable play. Notice the next three support levels, as indicated by the green lines on the above chart. We could easily see a move to 52% or lower before any turnaround in the trend, based on this sector's history.
Whether you're a stock trader shorting Burger King (BKC) or Sonic (SONC), or you're buying put options on the PowerShares Leisure & Entertainment Holdings ETF (PEJ), this sector could earn you a decent return in the near term. (Please note that these are not recommendations, but simply examples to illustrate the many ways to play the restaurant sector.)
'Steel' Away Into the Night
Although I did not personally make a restaurant sector play, I did take positions in the steel-and-iron sector recently. Here's why:
The sector turned around from the circled "O" (pointed to by the arrow on the right) and rose to 95.45%. Then some companies put in point-and-figure sell signals, and it again dove to 83.33%. Another turn and it surpassed its previous high, reaching a whopping 95.83%.
For perspective, the previous high for the last 10 years was late December 2003, at 89.19%. So the sector was incredibly overbought.
In my eyes, it had nowhere to go but down. I waited, however, for the turn -- knowing that a sector can stay overbought for a very long time.
So, I decided to do an experiment. In my trading account, I shorted United States Steel (X) -- a security with which I'm pretty familiar and, as such, I've had great success with trading it in the past. In my IRA, I bought put options on United States Steel.
After my positions were entered, the sector continued downward.
Now, as you see above, there was a brief interlude where the sector traded up again, in a similar fashion as it did in 2008 (the large circled area just left-of-center). It rose again to a level of previous resistance and reversed. But look at what happened last time it rose to this level!
Given this sector's history (always an important consideration), I wasn't too worried by this toying with the previous top.
As of today, the shorted stock (purchased on the 23rd) is up 14.8%. The put options (purchased on the 24th) are up 35.92%.
Who says using options are riskier than trading the underlying securities? Not me!
Don't Cry for Me, Latin America
You probably noticed in the Industry Bell Curve above that I circled the two sectors currently in the 70% region. Both of them are outside the United States. The first of these is Latin America. Here's its Bullish Percent Index chart:
I've marked the three most-recent resistance levels in black lines and numbered them. The previous resistance of 2005-'06 could have turned into a support level if the recent activity had held at the January 2007 level, but it didn't. In June, the sector fell through that line.
I've also highlighted in pink the 80-90% range to point out the history of the sector at this level. It typically will fall to at least the support represented by the yellow band (58%-62%) before "deciding" to attempt another rise, or simply falling farther. It has generally established a resistance somewhere under 70% (again, the numbered black lines) before tanking.
Given this history, the sector is ripe for profit-taking as a short or option play. The cautious among us will wait for Sector Hunter's 70% signal before entering the fray.
Gonna Watch That Stock Rise Out of Thin Air
The second sector in the 70 percentile is the Asia-Pacific sector. Here's its current BPI:
I've also highlighted in pink the 80-90% range to point out the history of the sector at this level. It typically will fall to at least the support represented by the yellow band (58%-62%) before "deciding" to attempt another rise, or simply falling farther. It has generally established a resistance somewhere under 70% (again, the numbered black lines) before tanking.
Given this history, the sector is ripe for profit-taking as a short or option play. The cautious among us will wait for Sector Hunter's 70% signal before entering the fray.
Gonna Watch That Stock Rise Out of Thin Air
The second sector in the 70 percentile is the Asia-Pacific sector. Here's its current BPI:
The "O" in the last column is pointed out just to show that the sector has proceeded below two (admittedly very close) points of past resistance (the black lines). The green lines represent past support levels. Again, the pink highlight is meant to show past behavior from this level. In July-August 2007, for example, the sector dropped rapidly and then climbed back up in September and October.
But I've also highlighted the middle in tan to point out how volatile this sector can be, therefore making it harder to peg down. And don't be fooled by the blue Bullish Support Line (BSL). The distance between the recent activity and the trendline is too great to ascribe any significance to the BSL. This is easier to see in the line chart:
Too much ambiguity here -- we can't be sure it will establish a trading range nor determine the degree to which it will waver. So, while it's quite possible that this sector is also ripe for shorting, I would spend more time researching the weakest securities -- do peer performance relative strength analyses on, for example, Korea Electric (KEP), News Corp. (NWS), Satyam Computer (SAY), Tata Communications (TCL), CNOOC Ltd. (CEO), James Hardie (JHX), PCCW Ltd. (PCCWY) and S.K. Telecom (SKM). And, for good measure, throw in the Short and UltraShort ETFs EEV, EFU and EUM.
Keep an eye on the near-term movement for the sector. Then, if you decide to jump in, use whatever timing tools you use to determine when to make an entry. And keep your stop-losses tight.
Until next week, happy hunting!
P.S. Five points to anyone who catches the musical spin-offs in the section titles!
(Please let us know what you think about Bob De Dea's article.)
Rate his article here »
Rate his article here »
Bob De Dea
Chief Investment Officer
<