The Week Ahead: Don’t Make This Investing Mistake
The stock market surged and swooned last week on earnings as there was a host of winners and losers. The tech sector had been the big winner the previous week and while LinkedIn (LNKD) surged over 10% last week, Twitter (TWTR) and GoPro (GPRO) recorded double digit losses.
The implications of merger talks between health care giants Pfizer (PFE) and Allergan (AGN) caused new focus on the health care sector which has been lagging on the current rally. Even more important to many investors was the sharp drop in Valeant Pharmaceuticals (VRX) which was rocked by an October 21st report from a noted short seller that VRX could be the next Enron. The stock has lost over 40% since the report was released.
Mutual fund giant Sequoia (SEQUX) has been in the cross hairs as reportedly two of its board members that had questioned the investment in VRX resigned last weekend. This large growth fund has total assets of $7.5 billion and I was surprised to see that it was rated five stars by Morningstar as I have great respect for their research.
I have consistently advised investors to carefully research any ETFs or mutual fund before they buy and I was surprised to learn that VRX makes up 28.7% of SEQUX. The second largest holding is just a 6.66% holding in Berkshire Hathaway Inc. (BRK-A) followed by 5% in TJX Companies (TJX)
From my perspective this very high concentration in one stock is contrary to the reason why investors consider mutual funds in the first place. At the end of July SEQUX closed at $272.72 which was very close to its starc+ band. By last Thursday SEQUX had dropped to $223.02, a loss of over 18%.
By the middle of August the uptrend, line a, had been broken. Three weeks later SEQUX had rallied back to its then declining 20 week EMA, point 1. This topping pattern was confirmed by the relative performance which dropped below its support, line b, and its WMA.
Valeant Pharmaceuticals (VRX) made its high in early August and three weeks later it dropped through support at line c. In September, the on-balance-volume (OBV) dropped below its WMA (point 2) and volume increased as VRZ moved lower. The weekly RS analysis was also indicating that VRX was no longer a market leader.
ETF investors and traders also need to be aware of the level of diversification in ETFs they are considering. For example, the Sector Select Health Care (XLV) has 55 holdings with 10.32% in Johnson & Johnson and 8.12% in Pfizer. In contrast the Vanguard Health Care (VHT) has a total of 336 holdings with 8.65% in Johnson & Johnson and 6.46% in Pfizer. Though both have too high a concentration in Johnson & Johnson VHT is clearly more diversified with 336 holdings.
The clear lesson from Sequoia (SEQUX) is that even the holdings in your mutual funds should not be ignored. If you are working with an advisor who recommends a fund, ask them if they have closely looked at the fund’s holdings. Their answer should help you decide whether you have the right advisor.
Hedge fund investors have also had to face the same problem as hedge fund manager Bill Ackerman spent over 4 hours in a conference call on Friday defending his $4 billion dollar position in Valeant Pharmaceuticals (VRX). The leading short seller in VRX announced while the call was progressing that the news could get even worse. This caused further selling in the afternoon as Ackerman’s position is showing about a $2 billion dollar paper loss.
Though many of the health care and biotechnology stocks have failed not rallied as much as the S&P 500 since the October 2nd lows the monthly analysis of the Vanguard Health Care (VHT) is still positive. VHT has been able to stay above its 20 month EMA in October with key resistance now at $136.77 which was the September high.
Multi-time frame relative performance and volume analysis plays an integral part in the specific trading and investing ETF advice that I provide in my Viper ETF Report. The monthly RS broke through resistance, line a, in May 2011. This alerted investors to the break through twelve years resistance by the health care sector the following year. With the monthly RS line now testing its WMA, the November close becomes increasingly important. Though the weekly RS analysis is still negative, the daily analysis (take note traders) does appear to be bottoming.
The monthly OBV has been in a strong uptrend, line b, since early in the bull market and did make a new high with prices in July. It will turn higher this month which continues to be a positive for the long term. Both the daily and weekly OBV (not shown) are positive but a surge in the daily volume is needed to signal acceleration on the upside.
The monthly chart of the NYSE Composite shows that the long term support, connecting the 2009 and 2011 lows has been tested over the past three months. The NYSE looks ready to close the monthly back above the 20 month EMA even though the final numbers are not in yet. The next resistance is in the 11,000-11,250 area while the upper boundary of the trading channel (line a) is in the 12,600 area.
The monthly NYSE A/D line moved above its WMA in May 2009, point 1, after being negative for the majority of 2008. The A/D line dropped below its WMA last month but has risen back above in October. Though the OBV is rising it is still below its flat WMA but well above the long term support at line c.
The high yielding large cap stocks have been some of the strongest stocks in October as the SPDR Dow Jones Industrial (DIA) is up over 10% as it looks ready to close the week just below the quarterly pivot resistance at $178.35. There is further resistance in the $180-$180.50 area.
The Dow Industrial A/D line closed above its short term downtrend, line c, and its WMA on Friday October 9th. This was one week after the important reversal on Oct. 2nd. The A/D line is still well below the longer term bearish divergence resistance at line b. The OBV is acting stronger than prices as it has moved well above the resistance at line d.
Interest Rates & Commodities
The yield on 10 Year T-Notes declined slightly last week after the recent bounce from below the 2.00% level . A decisive close above 2.30% is needed to break the downtrend of lower highs, line a, and lower lows (line b). A decisive close below 1.98% is needed to reinforce the downtrend.
I was looking for one more rally before the rebound in gold was over but with last week’s close below the prior two week lows suggests that the rebound is over. The rally from the July lows looks like a bear flag formation, lines a and b.
The weekly OBV broke support, line f, In July which was a sign of weakness. The OBV dropped below its WMA this week suggesting that the rebound is over. This indicates that vertical put spreads should be established on any rally. I will be looking for a good risk/reward trade in the next week or so.
Crude oil closed higher this week but a weekly close back above $48 per barrel is needed to signal a move back above the $50 level. The volume analysis has improved over the past three weeks.
There was not much good news for the economy last week as the Dallas Fed Manufacturing Survey was expected at -6.0 but it came in at -12.7. New Home Sales were also lower than expected. On Tuesday Durable Goods were also weaker while the flash PMI Service s came in as expected.
The Consumer Confidence dropped from 103 last month to 97.6 this month which was below the consensus reading of 102.5. Much of the decline was attributed to the view that fewer jobs were available than last month. As Econoday commented “five regional Fed reports all showing negative headlines for October. The Richmond Fed index did improve, however, to minus 1 from September’s minus 5.”
The preliminary 3rd quarter GDP last Thursday came in at a slightly disappointing 1.50. This is down from the 3.9 reading in the 2nd quarter. The Atlanta Fed is looking for growth of 2.5 in the 4th quarter. Also on Thursday the Pending Home Sales at -2.3% were quite a bit weaker than the expected gain of 1.0%.
Friday’s Personal Income and Outlays came in lower than expected showing no signs of impending inflation. The Employment Cost Index did come in a bit stronger than expected which was a bit better than expected. On the plus side was a surprising jump in the Chicago PMI which came in at 56.2 while most were looking for 49.1. The University of Michigan’s Consumer Sentiment reading of 90 on Friday was just down slightly from 92.1 in the middle of the month.
This week’s PMI Manufacturing Index and the ISM Manufacturing Index may be in contrast with the some of the weaker numbers that have come from the Fed regional surveys. Factory Orders on Tuesday are expected to stay weak but the focus for the week will be on Friday’s monthly jobs report.
In addition to the ADP Employment report on Wednesday we have the PMI Services Index and the ISM Non-Manufacturing Index.
Stocks were mixed Friday and for the week there were slight gains in the Dow Industrials, S&P 500 and Nasdaq Composite while the Dow Transports along with the Utilities were down over 2%. The A/D ratios were slightly negative for the week.
For the month the Dow Industrials were up 8.5%, followed by a 8.3% gain in the S&P 500 which was their best monthly gain since October 2011. The Nasdaq Composite was even stronger as it recorded a 9.38% gain for the month. This performance supports my view from August (The Week Ahead: A Replay of 2011 or 2012?) that the market could follow a similar course as it did in 2011.
The fact that earnings season has not been as bad as projected has been supportive for the market and i though that analysts were too negative before the earning’s season. The weekly chart of the Spyder Trust (SPY) shows that prices have reached the previously identified resistance zone ( lines a and b). A weekly close above $212.08 would be very bullish. There is first good weekly support now at $201.35 and the now rising 20 week EMA. The 50% support and the quarterly pivot are now in the $195 area.
The weekly S&P 500 A/D line tested the support from the 2014 lows, line d, on September 25th. Two weeks later the A/D line was able to move above its WMA and the downtrend, line c. On any correction the A/D lines should hold above its rising WMA.
The iShares Russell 2000 (IWM) managed just a 5.6% gain for the month. The downtrend, line a, was tested last Wednesday as IWM rallied on heavy volume (point b). This may be an early sign that the small caps are going to start to catch up with the other major averages. We should know this week as so far the pullback from Wednesday’s high is holding well above its 20 day EMA.
The IWM has been holding on a Friday’s closing basis above the quarterly pivot at $114.19. The OBV broke its downtrend, line c, several weeks ago but there needs to be stronger volume in order to confirm that a bottom is in place. Once above last week’s high at $117.14 the next key resistance is in the $120-$121 area.
Health care had the best week as it gained 3.1% which was much better than the 1.1% rise in the consumer services sector. Still it slightly lagged the S&P 500 for the month as this table from FT.com indicates. It also shows that the materials were the leader by far as the S&P 500 material sector was up 13.45%. There were four sectors that did better than the S&P 500 including energy, info technology and industrials.
What to do?
The example of mutual fund Sequoia (SEQUX ) and VRX I hope will encourage you to find out what is in your ETF or mutual fund. This information is readily available from sites such as Morningstar and I also provide portfolio analysis for individuals.
Now that the major averages have reached major resistance it is also a good time to review your holdings especially if you had a high concentration of stocks heading into this summer’s correction. If you have recouped many of your paper losses it would be a good time to reduce your exposure and raise some cash.
Though I do expect the market to move higher as we go into the end of the year the market is vulnerable over the short term so a pullback cannot be ruled out. Though it does not look likely as I pointed out last week investors should always be on the lookout for major reversals.
The fact that the PowerShares QQQ Trust (QQQ) has been testing its daily starc+ band for most of the past week was the reason I advised traders to take some partial profits last week. If we do get a correction this week I will be watching it closely for new entry points in some of the market leading ETFs.