Predicting vs. Trading: What to Look Out for This Coming Week

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 |  Includes: ABX, CMG, CTRP, GDX, SOL, TAN, VIT
by: Mercenary Trader

by Mike McDermott

Tradition has it, that at the beginning of each new year, strategists offer their predictions and expectations for the coming 12 months.

Economists handicap GDP figures for the US, Eurozone and Emerging markets. Asset allocators focus on predictions for bonds, commodities, equities and currencies. Trading desks usually draft a report on the top 10 bullish and bearish securities. And most of these exercises are nothing more than an attempt to get clients of all shapes and sizes involved and believing one story or another.

Unfortunately, the problem with most of these predictions is that they are simply worthless when it comes to day-to-day trading decisions. Sure, some soothsayer will accurately peg the strongest industry for the coming year, and sometime in December, we will reverently read about his insight with admiration. But until we know which of the illustrious arguments will turn out to have the most accuracy, all we have is a number of conflicting opinions.

I had to laugh this weekend as I read through Barron’s. Alan Abelson led out the year with a piece titled “Signs of a Top?” which focused on technical red flags and an expectations for falling prices. Of course Michael Santoli’s column this week was titled “A Major Top is Unlikely Soon” and gave a number of reasons why investors should expect bullish trends to continue.

So who is right? Is it really possible to accurately predict what the market will do in 2011? Are you willing to risk your hard-earned capital on one of these well-articulated arguments?

Instead of predicting the 10 stocks you NEED to buy or sell for 2011, I’ll simply agree with Jack’s discussion of market themes and trading waves – and then we can take a look at the waves that are setting up right now and offering us opportunity today (if not for 2011 as an entire year).

Commodities Continue

As 2010 drew to a close, both hard and soft commodities were surging.

Growing global demand for food continues to support higher prices for ag commodities. Uncertainty surrounding western fiat currencies has institutional and individual investors looking for alternative places to store wealth – benefiting precious metals. And hopes of a rebounding global economy have given oil and natural gas bulls reason to celebrate.

Strong ag pricing is especially good news for fertilizer companies, which have provided us with a number of profitable bullish trades in 2010. However, higher prices for grain, beef and poultry is becoming more of a challenge for restaurant stocks – with low margin Quick Service Restaurants (QSRs) facing significant pressure.

Chipotle Mexican Grill (NYSE:CMG) is picking up momentum after breaking below the 50 EMA last week (click on chart to enlarge). The stock has an extremely high multiple, as investors respect the company’s impressive past growth rate.

But while store expansion will continue in 2011, tighter profit margins should provide a significant headwind for earnings. And of course there is concern whether the company will find enough attractive locations to keep individual store revenue and profit metrics at such an attractive level.

With the stock priced to perfection (32 times 2011 expectations), there is plenty of room for the stock to fall – and if those expectations prove too optimistic, the damage could be even worse.

A new leg higher for precious metals is of course good news for gold and silver miners.

In the second half of 2010, we focused primarily on junior gold and silver miners, as speculative traders pushed these shares higher due to their strong optionality. Today, it appears the sentiment is shifting just a bit to where the primary gold miners are now in favor with more stable reserves and plenty of cash flow for production.

The Barron’s cover story this week gave 10 under-priced large cap stocks which could catch investors’ attention in the coming year. Again, we’re not much for outright predictions but I found it interesting that Barrick Gold (NYSE:ABX) was number four on the list with ample reserves and a stock price of just 13X forward earnings.

Barrick is the largest holding in the Market Vectors Gold Miners (NYSEARCA:GDX) representing 16% of the ETFs constitution. GDX is rebounding off the 50 EMA and the positive trend appears to be intact. A long position here can be set up with minimal risk (using a stop order below the December low), and plenty of room to run if precious metals remain in high demand (click on chart to enlarge).


Solar Rebound In the Works

As traditional energy prices continue to push higher, we’re expecting alternative energy to catch more attention. The solar area was hard-hit in the second half of 2010, as renewed European fears cut expectations for government subsidies.

But the economics for the industry continue to improve – as higher traditional energy prices make it easier for alternatives to compete, and technology advances make solar projects more efficient (and profitable).

The Guggenheim Solar Energy (NYSEARCA:TAN) ETF appears to have found support above $7.00 and a break higher from this point would push the broad ETF back above the 20 EMA and begin to challenge the 50 day average (click on chart to enlarge).

This trade would be more of a speculative opportunity as we are very early in the recovery cycle. But with Mercenary Trader portfolios holding plenty of bearish exposure, a long solar position would offer balance, while still providing an attractive setup with potential profits far exceeding the amount we are willing to risk.

ReneSola Ltd. (NYSE:SOL) also appears to have found support in December, and is still trading right at the 200 EMA. The company should finish 2010 with $1.91 per share in profit and analysts are calling for $2.05 per share in 2011. With the stock trading below $9.00 per share, investors are pricing in a tremendous amount of risk.

At this point, any positive news could drive the stock sharply higher – and considering SOL broke $15 as recently as October, it is clear that the animal spirits can kick in when the bulls become optimistic. We’re considering entering on a break higher (we typically use stop / limit orders for entry) and will use tight risk points with plenty of overhead room to run.

EM Still Under Pressure

Despite a relatively strong open for Asian markets, we’re still relatively bearish on Emerging Markets.

China’s economic growth has come at a cost, with inflation pressures escalating, and policy makers struggling to find the proper balance between continuing to foster growth, and promoting price stability. Recent rate hikes have investors on edge, and high-priced emerging market securities are vulnerable.

Vanceinfo Tech Inc. (NYSE:VIT) is a Chinese outsource company for software Research and Development. The company has experienced strong growth as developed nations can use VIT’s services efficiently in developing technology solutions. But with trade concerns mounting, currency fluctuations, and rising wage pressures in China – that competitive edge may be declining.

The stock surged to a new high at the beginning of December, but quickly fell back on strong volume. Investors are paying roughly 35 times future earnings, despite the fact that VIT’s profit growth is expected to decelerate in 2011.

A break below last week’s low could set off a number of sell orders from both technical traders as well as long-term value investors (click on chart to enlarge). The company has been impressive, but paying a premium price just may not make sense in the coming year.

Chinese travel firm Ctrip.com International Ltd. (NASDAQ:CTRP) also looks vulnerable after losing momentum late last year. The stock has experienced a series of lower highs and lower lows as investors fear travel growth rates are likely to decline.

Despite a 20% drop from its recent high, CTRP is still priced at more than 40 times 2010 earnings expectations and 30 times 2011. Considering the risks to these earnings expectations, we could see that multiple continue to contract in the coming weeks and months.

Given the fact that this wave has already crested, our probability for a successful short trade appears to be very good. The key issue at this point is picking the right inflection points, and setting risk points that are wide enough to give the stock room to breathe, while still carefully protecting our capital (click on chart to enlarge).

We’ve got a great year in front of us as shifting macro forces will undoubtedly give us plenty of attractive trading opportunities. So while I can’t tell you how many percentage points the Dow or S&P will gain or lose this year, I CAN tell you that we will be taking this year step by step – booking our profits and managing our risk day in and day out.

Disclosure: As active traders, authors may have positions long or short in any securities mentioned. Full disclaimer can be found here.