ETF Blog: Analysis And Buy Candidates For 7/15

Economic summary

With no major geopolitical events, the markets ground higher, and jumped in response to Mr. Bernanke's loose money comments on Thursday. There was little reaction to specific economic news, but I'm guessing the slow economic grind higher is what is pushing this market.

Retail sales growth held steady and firm in June. Mortgage rates continued rising and continue to choke off demand for mortgage applications. The average rate for conforming 30-year mortgages is up 10 basis points in the week to 4.68 percent for the highest rate since July 2011, and applications are down.

Jobless claims are up, but special factors make the data market neutral. Inflation is higher at the producer level, primarily in cars and petroleum. Core inflation is up slightly. This indicator could portend Fed tapering. Producer prices don't always transfer to consumer inflation.

The Fed's economic forecast is improving, as GDP was revised higher; however they are starting to worry about inflation.

Investor sentiment is improving according to the TD Ameritrade IMX report, which rose 3% in June; however small business optimism fell back slightly. The consumer comfort index is overall at a 5-year high, but expectations are off. The Consumer Sentiment report was essentially flat.

From the data, my conclusion is an economy steadily but slowly improving. We have to look at rising sectors and good companies within to find stocks or ETF's in stable uptrends. Tightening, when it comes, will disrupt things for a time, after which the overall uptrend will continue.

Market trend analysis

The S&P 500 continued with another week of daily doji's, small body candlesticks separated by gaps. Since the gaps are caused by Asian, European, futures, and U.S. premarket trading, U.S. investors seem to be letting the rest of the world do the heavy lifting. The trend is well over 96%/year, ahead of the previous 82% trend. I interpret this to be a weaker pattern because of the gaps, and because volume is slightly below the 50-day average. Nevertheless, the trend has been intact for 13 days.

The "Bernanke swoon" began with the introduction of "tapering" on May 22, became violent in June when the Fed hinted the economy is improving, and ended Friday, as the index returned to the previous all-time high, as the Fed allowed that tapering would not happen quite as soon.

Small caps (IWM) are even stronger, rising along a well-formed trend at 141%/year. IWM weathered the swoon with relative little drawdown, and there is no resistance above. IWM in an uptrend is my trigger for becoming fully invested.

Volatility & Sentiment

The VIX fell sharply during the last two weeks from a peak of 22 to a close at 13.9. A low VIX argues for a continuation of the uptrend. Various sentiment indicators (Consumer Comfort, Consumer Confidence, Investment Movement Index, and Small Business Optimism) last week were positive, but off slightly from prior readings.

Most earnings announcements beat the consensus, including JP Morgan and Chase. Next week, watch C, CSX, INTC, CMG, as possible market movers.

Leading ETF's

The relative strength charts, available interactively at http://bit.ly/TvHtd8, are set to 13 days to capture the leaders in the new uptrend.

The core ETF chart shows ten ETF's that cover most of the major economic sectors. I invest first in the top performers and then add specific funds that outperform them from a sector list. I use IWM, which tracks the Russell 2000 small cap index, as the basic indicator of the overall strength of the market. When it is in a downtrend, I start raising cash.

As was the case last week, IWM is the strongest fund in the core chart, and it is on a smooth uptrend. Immediately following are retail (RTH), and financials (XLF). Real estate (IYR) has strongly rebounded, but is somewhat choppy. I usually prefer funds with smooth uptrends to reduce the frequency of being stopped out, but will occasionally jump into something like TAN.

Last week I discussed REITs (IYR, pink). It rose sharply on Thursday, but fell back on Friday. Interest rates are rising and investors will have to understand how REITs will behave in an environment with less stimulus. Once they do, I am guessing that IYR will stage strong recovery.

Solar (TAN, brown) has once again resumed its strength, but it was overtaken Friday by biotech (IBB, turquoise). Because IBB is high priced ($193), I favor BBH, which performs similarly. Internet stocks (PNQI) are moving smoothly higher. These funds all outperform IWM.

Conclusion

I am currently long BBH, XLV, IWM, XLK, IYT, and IYR. Stocks I like are LMT, HPQ, and DDD, and am guessing that absent negative Fed announcements, with a moderate boost from earnings season, the market continues to trend higher next week.

If I can find room in my portfolio, I will add to IWM and BBH, take a small position in TAN, and consider RTH and XLF. If any fund breaks trend, I'll cover with protective puts, and sell if a downtrend forms. If IWM breaks trend, I will not add new positions and raise cash.

Have a great week!

Disclosure: I am long BBH, IWM, XLK, IYT, IYR, HPQ, DDD, LMT.

Additional disclosure: Contact me for information on how I measure and act on trends.