Traders are returning to their desks this week with plenty of uncertainty, as equity markets exhibit schizophrenic tendencies…
Last week, markets were poised to turn in a disappointing week until a major surge on Friday. The bullish price action came as a result of a better than expected US jobs report - along with a re-assessment of Draghi's comments regarding ECB bond purchases.
The rally gave bulls the comfort of a significant price advance in a short period of time, but failed to do much to change the overall technical or fundamental picture.
Not only are key problems still unsolved in Europe (politicians still have not reached a solution for how to bail out Spain and Italy), but the strong US jobs report actually left a lot to be desired.
- While the headline number came in above expectations, 163,000 jobs created is not even enough to keep up with population growth.
- The unemployment rate ticked higher (to 8.3%) even as 150,000 individuals "left the workforce" which means they are no longer counted as unemployed.
- One in seven Americans are still either unemployed or underemployed.
- And even if the employment picture was improving, it would actually make it less likely that the Fed will act aggressively at its next meeting.
The resulting surge in equities was largely propelled by institutional managers chasing performance, along with plenty of short covering as the blue-chip averages hit new short-term highs. Small-caps (via the iShares Russell 2000 Index - IWM) are acting as a canary in the coal mine, trading back to the high end of a descending channel - and facing major overhead resistance.
In today's bi-polar market environment, we're finding a number of attractive short and long candidates as high-beta risk assets are being bid to unsustainable prices, while some deep-value and oversold areas still offer compelling reward-to-risk opportunities from the long side.
Some of the biggest and fiercest short-term rallies occur during secular bear markets, as volatile sentiment levels and short covering can drive prices sharply higher for a time. Today's market environment favors the nimble trader, as fundamental assumptions continue to be challenged and institutional capital moves swiftly from sector to sector in search of a performance edge.
Below are a few of the trading areas we are monitoring this week…
Retail Feels the Pain of Slowing Consumer Spending
Retail stocks have held up surprisingly well throughout the last year - this despite high levels of unemployment and even higher levels of underemployment.
For retailers catering to low income spenders, a material portion of revenue growth has come because a large segment of the consumer base has migrated from the middle class, to the low-income consumer group.
This can be seen by the relative difference between middle class retailers like Abercrombie & Fitch (ANF) - down 62% from its 2011 high, and discount retailers like Family Dollar Stores (FDO) - up 36% over the last 12 months.
Retailers catering to the affluent initially held up as well. With unemployment much lower for workers with hefty incomes, spending patterns remained stable. Even affluent spenders who dealt with unemployment still had the ability to spend by tapping into savings or established credit lines.
But as the global economic picture has continued to deteriorate, both discount and luxury retailers are dealing with lower levels of spending.
Last week Harley Davidson (HOG) CEO Keith Wandell issued some sobering comments in conjunction with his company's disappointing second quarter revenue figures:
…we're sort of swinging back into being more conservative and trying to figure what's going to happen with the global economy and the election and where our economy is headed.
HOG dropped sharply on the day and, while it has recovered somewhat from last week's lows, the stock is well off its highs and in a bearish pattern.
The entire retail sector is looking more and more vulnerable as key components issue poor revenue numbers and lower guidance. We've got our eye on a number of high-growth names that have strong potential to disappoint investors, along with a bearish perspective for ETFs representing retailers in general.
Energy Stocks Offer Compelling Valuations
Whenever a particular group shows up on the front page of a widely-circulated publication, it pays to be skeptical. But this week's issue of Barron's has a front page article that actually makes a very compelling case for a number of energy companies.
Even with lower crude oil prices, and a nationwide glut of natural gas, stock valuations remain at attractive levels. On top of that, robust dividend payments are attracting capital as investors reach for yield in an era of record-low interest rates.
Major integrated stocks like Chevron Corporation (CVX) and ExxonMobil (XOM)are likely to attract capital based on low PE ratios and attractive dividend yields, while E&P (Exploration & Production) companies likeApache Corp (APA) and Anadarko Petroleum (APC) are attractive based on the magnitude of their oil reserves.
Barron's notes that analysts believe many of these companies are trading at exceptional values - even without the benefit of higher commodity prices.
With sentiment relatively poor due to the weak price action in crude oil, these names could offer a compelling reward-to-risk opportunity on the bullish side.
Any sustained positive action in crude could continue the fresh uptrend in energy names. Meanwhile, the dividend yields and the valuation of underground reserves can continue to attract capital and offer price support.
Emerging Markets Oversold, Underowned
They say it's impossible to commit suicide by jumping out of a basement window…
The logic may well apply to a number of emerging markets, where equities have pulled back significantly and now trade at cheap valuations.
In 2011, the Brazilian economy passed the UK to become the world's 6th largest economy. The country benefits from a wealth of natural resources along with a rapidly growing middle class.
Investors have let emerging market equity shares tumble as risk appetite has waned, but that action could be reversed in the coming weeks.
Shares of Brazilian equities could be bid up quickly simply as a result of a "risk-on" move as portfolio managers pick up beaten down holdings in search of long-term value. Economic growth prospects also offer long-term potential for price appreciation, in a global environment where robust growth is hard to find.
Shares of the iShares MSCI Brazil Index Fund (EWZ) have found support in the low $50′s and could complete a breakout over the next few sessions - capturing the attention of momentum buyers along with performance-chasing institutional buyers.
Back in the US, the prospect for corporate earnings growth may be much darker than most Wall Street analysts are willing to admit. John Mauldin offered a particularly bearish perspective over the weekend, noting the cyclicality of corporate earnings and the probability a major contraction (if not decline) in earnings over the next several years.
On top of that, August has typically been one of the most bearish months of the year - with September and October also carrying risk of major volatility - putting us in a very uncertain period for US equities.
As evidenced by the Live Feed Trend Tracker (part of our Mercenary Live Feed), a large number of the markets that we track are in neutral territory - this despite Friday's surge in equities.
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We continue to find both bullish and bearish opportunities in today's market, focusing primarily on short-term swing trades while waiting for more macro clarity before entering longer-term trend trades.
So far this earnings season, we have seen a continued trend towards EPS beats but disappointing revenue numbers. Guidance from management has also largely been negative.
Trade 'em well this week!
Disclosure: As active traders, authors may have positions long or short in any securities mentioned. Full disclaimer can be found here: http://mercenarytrader.com/legal/