Month: March 2014

This week investors will be playing close attention to biotechnology, social media and other momentum leading sectors to see if the sell-off has ended. One bright spot was the Global X Social Media Index (SOCL), which bounced on Friday – right on schedule after hitting support. Guggenheim Solar (TAN) bounced as well.

The strongest sector coming into this week is energy. Oil prices rallied last week and carried the energy equities higher along with it. Fidelity Select Energy (FSENX) is near its post-2008 high and Energy Select SPDR (XLE) broke out to a new high last week. Oil service stocks are also breaking out. This could be bullish for the market and good news for the economy in general, since a rise in oil prices cannot be sustained in a weak economy.

It may also be a very early sign that inflation is picking up. As we noted a few weeks back, bank loans have increased in the wake of tapering and these financial institutions create the vast majority of money in the economy. If the pick-up in loans continues along with rising energy prices, we may soon see higher growth along with inflation, which would be very bullish for the commodity producers.

What may be underway in the market is a change in leadership. Based on the sectors moving up, this could indicate we are in the the middle stage of the bull market. During the period, but utilities begin to outperform, along with energy and materials. This is the period when interest rates start rising and growth hits its peak. This would also suggest momentum leaders such as biotech, Internet and solar rebound and move on to new highs, but that other sectors begin outperforming in the months ahead.

Economic Reports: Purchasing Managers’ Indexes for several nations are out this week. Construction spending in February, motor vehicle sales for March, factory orders for February and the trade deficit for February are all out this week, in addition to the unemployment number for March.

Earnings: A light week for earnings before the season kicks off with Alcoa (AA) next week.

Biotechnology has been the topic of intense interest over the past week.  Through the close of the market on Friday, the NASDAQ biotechnology index had lost over 13 percent on the month.  Nearly half of those losses have come in the last week, and over 2 percent on Friday.

I have received a number of calls from members questioning the biotechnology sector and the explanation behind the sell-off. Without a doubt, the sector has historically been one of the more volatile portions of the market.  The companies create cutting edge medical treatments and if clinical trials do not meet expectations, the stock price can plummet within only a few hours.  Alternatively, the results of successful testing can move the stock upwards 30, 40 or 50 percent or more almost immediately.  In fact, Intermune (IMTN) jumped over 170 percent a few weeks ago due to positive results for its lung disease drug.  Such rapid price changes can also have a contagion effect upon other firms in the sector.  If a panic occurs, not only will one company suffer, but often spreads to other firms within the sector.

For biotechnology mutual funds and ETFs, the impact of a few companies can have a dramatic impact on the fund.  These funds often have a low number of holdings.  Market Vectors Biotech ETF (BBH) has 25 positions and SPDR S&P Biotech (XBI) has only 82 holdings.  Fidelity Select Biotechnology (FBIOX) has 163 positions but the top 5 holdings comprise nearly 40 percent of the portfolio.  Similarly, iShares NASDAQ Biotech (IBB) has 123 holdings, with the top 5 stocks making up 39 percent of the fund. If you are seeking broad diversification, biotechnology is not the sector you should be looking at.

Given the hefty weightings of a just a few firms in these funds, any change in their business can have a dramatic impact.   FBIOX’s largest holding is Gilead Sciences (GILD) and is nearly 15 percent of the fund.  For IBB, GILD is the fourth largest holding, with a 7.6 percent allocation.  BBH has GILD and it is the largest holding with a 12.12 percent allocation.  Gilead is not alone – Amgen (AMGN), Biogen (BIIB) and Celgene (CELG) are also companies that have significant exposure across the same funds.

Gilead has been one of the leading drivers behind the sector moving higher and now moving lower.  On February 25^th, Gilead closed at $83.95.  This past Friday, the stock closed at $68.55, a decline of over 18 percent.

By most accounts, Gilead is a solid company with innovative drug treatments for HIV and hepatitis.  In fact, its hepatitis C drug, Sovaldi, has been shown to provide a 90 percent cure rate in Phase 3 trials.  With over 3 million people infected with hepatitis C, Solvadi may prove to be a revolutionary drug that has a sweeping positive benefit.

A 12-week treatment program costs $84,000.  With such high potential demand, the financial prospects for Gilead look promising.  A problem surfaced earlier last week: it was publicized that the House Committee on Energy and Commerce sent a letter to Gilead questing the pricing structure of the drug.  The stock dropped, pulling other biotech companies down with it.

To summarize – this is a solid company which has created an innovative drug needed by over 3 million people in the United States alone.  Globally, the demand will be even higher.  Analysts widely view Gilead’s prospects positively, with some indicating the stock could move up to $95 a share.  Actively managed FBIOX clearly favors the firm as it has a 14 percent weighting.

What has occurred should provide an important reminder to investors.  Sometimes a stock price can be influenced by more than the fundamental strength of the company.  It may have sound financial practices, innovative products and strong management.  In this case, a letter sent last week had a massive impact on Gilead and the broader biotechnology sector.  If the pricing inquiry doesn’t gain momentum, there is absolutely no reason why the sector can’t rebound by 10 percent or more over the next week or two.

Certainly, biotechnology has been on a great run and a correction was inevitable.  Unfortunately, a correction can be started or exacerbated by seemingly minor events.   This is the nature of volatile sectors – speculation can cause dramatic swings.  As biotech has been a market leader, your positions may have become a significantly larger percentage of your overall portfolio.  It may make sense to take some profits and rebalance your holdings so you do not have oversized exposure to aggressive areas of the market.

The markets looked to rebound today after Thursday’s losses.  While giving up some of the early morning gains, the S&P 500 and Dow Jones Industrial Average managed to increase 0.46 and 0.36 percent, respectively.  For the week, the S&P 500 fell 0.5 percent, while the DJIA rose 0.1 percent.  The technology heavy NASDAQ fared far worse, down 2.8 percent.  As it turned out, it was the worst weekly stretch for index in 15 months.

Without a doubt, it has proved to be a challenging week for the markets. First, economic data came in weaker than expected.  New home sales fell 3.3 percent in February, coming in at an adjusted annual rate of 440,000, lower than analyst forecasts.  Additionally, January’s report was also revised lower, down to 455,000. Existing home sales, which account for the vast majority of purchases, also fell for the second consecutive month.  With the Federal Reserve indicating rate increases coming in the near future, a broader pickup in the economy will be needed to offset higher mortgage rates.

On Monday, the Markit preliminary U.S. Manufacturing Purchasing Managers Index (PMI) fell to 55.5 after posting a 57.1 report last month.  While it was below analysts’ expectations of the 56.6, it is still well ahead of the 53.7 we saw in January.  Moreover, the services sector picked up with a reporting of 55.5, up from 53.3 in February.  The composite index of both manufacturing and service sectors came in at 55.8, and improvement of over the 54.1 reporting.  Placed in context, any report over 50 shows a growing economy even if it is a slow rate.

Markit’s Chief Economist, Chris Williamson summarized the indicators by stating in his commentary:

“Service sector activity rebounded in March after a weather-torn February, but the survey is clearly flashing some warning lights as to whether the economy has lost some underlying momentum and that growth could slow in the second quarter.”

 “Even with the rebound, the two PMI surveys are merely consistent with annualized GDP growth of approximately 2.5% in the first quarter, largely unchanged on the disappointing 2.4% rate seen in the fourth quarter of last year.”

After Williamson’s comments, it was announced that fourth quarter GDP growth was revised up from 2.4 to 2.6 percent.  The driver behind the revision was the largest uptick in consumer spending in three years.  This certainly provides a positive sign, but due to the harsh winter, we do not expect to see an improvement on those numbers in Q1 2014.

Taking that into consideration, the National Association for Business Executives (NABE) stated that while we will have slow growth over the short-term, it should accelerate as the year goes on.  For 2014, they expect real GDP growth to be 2.8 percent, followed by 3.1 percent growth in 2015.  The also view the probability of another recession to be 15 percent.

Over the short-term, we expect to see an increase in volatility, especially if the Q1 earnings season has companies providing results that miss expectations.  As we track in our Global Momentum Guide, the short-term leaders have retreated. Biotechnology stocks were sold off continuously over the week, and are down significantly again today.  While this is disconcerting for investors, remember there was a large sell-off from January, before the sector again rallied.

We have recommended biotechnology in our models for some time and have enjoyed a healthy return over that period.  As biotechnology has historically been very volatile, investors must be comfortable with weeks where the funds may increase or decrease by 10 percent in only a few trading days.  For investors who have seen returns of 50 percent or more in this sector, you want to be careful these positions are not outsized relative to the rest of your portfolio.  If they are, you may want to take profits and move those gains to more conservative options.

Technology has also lost ground.  Google (GOOG) suffered its worst week in more than two years. Social media stocks struggled as well, with Facebook (FB) sliding more than 10 percent. Some Internet funds have fallen for three straight weeks; two of the Internet ETFs we track in the Global Momentum Guide have lost value on 12 of the past 15 trading days.

Important Note: You can view the latest momentum rankings, plus buy and sell recommendations each Monday on our website.

Despite the lackluster reports, as a whole the broader indexes held up very well.  Keep in mind one good week can push the S&P 500 Index to another new all-time high. Ultimately, losses were concentrated in the more volatile sectors of the market.  This is a good sign. Furthermore, some technology sub-sectors are nearing technical support levels and many have become oversold, indicating a bounce next week is likely.

Two Important Updates from the Mutual Fund Investor Guide:

Finally, we would like to update you on some additional tools that can help you manage your investments:

1. We have begun publishing the model portfolios, rankings and data for our new Global Momentum Guide.  For the next 2 weeks, we will be making our proprietary momentum based trading strategy available absolutely free of charge.  The latest recommendations are uploaded each Monday.
2. The first issue of the Investor Guide to Vanguard Funds will be published on April 15^th.  If you have not yet had the opportunity to subscribe, please visit:  https://www.mutualfundinvestorguide.com/subscribe/vanguard-funds-signup/?s2-ssl=yes

iShares Dow Jones US Home Construction (ITB)

One of the losers from the Fed’s policy statement last week and Janet Yellen’s rate hike comments may be homebuilders. The fund is back to where it began 2014, giving back all of the large gains that came last week on positive earnings from homebuilders. Higher interest rates will push up mortgage costs for homebuyers, lowering the price they are able to pay for a home.

Another factor may be federal legislation aimed at winding down Fannie Mae and Freddie Mac. The current proposed law does not have enough support to pass, but it does look as though Congress is ready to reduce the role of government in the housing market. This will also push up mortgage costs as the government is currently subsidizing the housing. Without that support, private lenders will bear the cost of bad loans. They will make credit more expensive and harder to obtain, reducing the pool of eligible buyers at today’s prices. Home prices may rise for other reasons, but this new factor will put downward pressure on prices.

iShares Nasdaq Biotechnology (IBB)
Global X Social Media (SOCL)
Guggenheim Solar (TAN)

The momentum leaders finally broke their 2014 run. While solar (TAN) is still holding up, biotech (IBB) plunged below its 50-day moving average on high volume. Social Media (SOCL) dropped along with other Internet ETFs. The losses weren’t confined to the U.S. either: PowerShares Golden Dragon (PGJ), a fund with heavy exposure to Chinese Internet companies listed in the U.S., dropped as well.

This current move lower takes SOCL into negative territory for 2014 and IBB has given up much of its gains for the year. All the high-flying names such as Tesla (TSLA), Netflix (NFLX), Amazon (AMZN) and LinkedIn (LNKD) are coming under pressure as well.

The current slide in these funds does not yet constitute anything more than a normal pullback following an intense run-up in shares. Individual charts of many leading companies reinforce this interpretation. There was also a similar dip in these sectors in late-January, when the broader market was selling off. Shares will need to fall a lot further before a bearish interpretation would even become a possibility.

db X-Trackers Harvest CSI 300 China A-Shares (ASHR)

China’s mainland stock market saw a huge bounce on Friday of last week following several stock market reforms. The securities regulator raised the limit on foreign ownership from 20 percent to 30 percent. Companies will now be allowed to issue preferred shares; that move spurred heavy buying in the banking sector, where many firms are expected to raise capital in the face of deteriorating loan portfolios. Finally, the Chinext market saw listing rules eased, opening the market to more industries as well as reducing profit requirements for firms.

As the chart below shows, the 2000 level has served as a solid support level over the past 16 months. Chinese stocks are unloved in China, with property seeing the most speculation. Additionally, the weakening yuan offers some support for stock market valuations. A move below remains a strong possibility since a bursting of the housing bubble would unleash some measure of panic in China. However, if China’s slowdown doesn’t become a crisis, stocks may be close to the bottom, if they aren’t there already.