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Being an Investor in a Trader's Market


Opportunities still exist. Here's how to spot them.

I've received hundreds of emails from readers with questions regarding establishing long-term core positions at a low-cost basis from which to trade, as well as methods to build upon them during the recent market pullback.

The following email exemplifies the type of questions I've received regarding this approach:

Hi Carl,

The talking heads seem to [be] touting this as the one that will reverse the current rally we have been experiencing.

When I look out to the weekly charts I see many stocks at support at either the 20 or the 50 sma/ema. Your thoughts would be very much appreciated.

I had been concentrating on building core positions at a low cost basis so I could build around those on a pullback, which I think we have at this juncture. Do you think my judgment is flawed, and should I be positioning for further downside or begin scaling in to stocks at recent price levels?


I agree that not only the market indices but also numerous sectors and individual stocks are bumping against resistance or sitting right at support levels; many are at key moving averages. As you recall, I'm not a buy-and-forget investor, but an active manager of longer-term positions in my growth portfolios.

As an income and retirement investor, the growth portfolio complements my income holdings, and is one method I use to provide inflation protection. Core holdings provide cost support insofar as they allow me to build positions at a lower cost basis from which to trade with the core underlying position.

For example, the recent March lows provided excellent opportunities to establish and add to core holdings. Without having to time the market, I was able to buy at multi-year lows and sell into the strength the market presented as it channeled to highs near 956 on the S&P 500.

On May 13, I posted the chart below cautioning I'd reached the upper end of the channel and the 200-day market value adjustment (MVA) loomed just above around 952. I cautioned readers to be ready for some profit-taking around that level.

Click to enlarge.

As the chart below illustrates, Mr. Market obliged, pulling back to the lower end of the channel around 878 on the S&P. It then held the 875 level through the rest of May in an 880-920 trading range -- with some very high volatility -- before running through 940 and establishing the recent high at 956.

Click to enlarge.

Notice how the index spent the first 2 weeks of June attempting to close above the 950 level -- without success. Also note how 950 has become substantial upside resistance. At this point, the 20-day MVA is also providing short-term resistance.

Technically, much has been made of the "golden cross" formation as the 50-day moving average (MA) has moved up through the 200-day MA. Be it an index or a stock, I have personally found this to be of little historic significance, though the distance a stock has moved relative to these averages has proven to be important in determining advantageous entry and exit points. Otherwise, the crossing of the 2 MAs is of little predictive value, particularly when the 200-day MA is in the process of moving lower -- and would move still lower, should the market significantly correct.

More importantly, as we approach quarter's end, the market is up 16% for the period and up over 24% for the past 4 months. Following the volume spike that occurred on May 8, the market was up over 40% from the March lows. The question now is where to go and what to watch for from here.

While technical analysis (TA) illustrates the market, it's the fundamental indicators (FEI) that define the market. I believe the current market setup and overall market environment is a perfect example of that distinction. At this point in the market cycle, the trend is being determined by the actions of the Federal Reserve and their continued commitment to quantitative easing.

As a result, sector allocations, diversification, and rotations are subjected to the Fed's impact upon the dollar and the perception of global recovery. Weak dollar plays and potential inflationary pressures are evident daily as sector rotations swing between materials, copper, commodities, agricultural chemicals-fertilizers, and the defensive eat-it-drink-it-smoke it, biotech, big-cap pharma, retail cohorts.

Tech, it would appear, has managed to once again create its own bull market and effectively construct a rotation within the sector based upon news flow, new product introduction, and anecdotal stories on subjects ranging from Steve Jobs' health to 3G (AAPL) phone preferences. The sector's a very volatile beta ride, at best.

While the trading range remains intact, the action is in the trading and rotation of these sectors. While it has been and remains a "trader's market," opportunity still exists for investors: By establishing and building upon long-term core positions as rotations move from overbought to oversold, profits can still be made. The recent volatility in the fertilizer stocks is an excellent example.

My approach remains to be focused on price-sensitive add- and entry points in the very highest quality names with the yield support necessary to withstand a breakdown of the trend channel below 875 on the cash S&P. This would allow me to add and trade around the position on a retest, and perhaps breakout above the 950 resistance level.

I'm adding to my convertible preferred holdings such as Bunge (BG), Freeport McMoran (FCX), and Archer Daniels Midland (ADM). I've also continued building positions in foreign ETFs tied to natural resources, commodities, and China. Australia (EWA), Canada (EWC), Brazil (EWZ), and Taiwan (EWT) -- with their hefty yields and recent pullbacks -- are good examples of where I'm looking.

In the fixed-income arena, rising inflation risk validates the basis of my retirement-income investing strategies. It requires diversifying over a wide range of sectors, making different types of investments that perform well during varying economic circumstances.

For the income-oriented investor, there's no bigger foe than inflation. However, in recent months, credit risks have become as worrisome as defaults, since bankruptcies and rising interest-rate risks have created loss of principal in fixed-income portfolios.

For example, Treasuries have registered their worst performance since 1978, falling more than 6.5% this year -- clearly signaling the end of the long-term bull market in Treasuries. On April 29, 30-year fixed-rate mortgage matched a record low of 4.78% as the Fed continued to hold the Fed funds rate at zero. I believe the Obama government, particularly in the face of rising mortgage rates, will provide whatever liquidity and fiscal stimulus necessary, regardless of the impact on the deficit or inflationary pressures.

As a result, I'm focusing on diversification among the highest rated corporate bonds and the strongest sectors with the essential service sectors.

For example, the highest rated companies in pipelines, unit trusts, master limited partnerships (MLP), and Canadian Royalty Trusts have held their yield payouts through the oil price turmoil even as their share prices have presented opportunities for entry.

Even with the House narrowly passing the American Clean Energy and Security Act, the likelihood of passage in the Senate without significant compromise seems highly unlikely. While the ultimate cost burden will fall to the consumer, there will be few big losers in the electric utility space. Even the heaviest coal burners, such as American Electric Power (AEP) -- the top CO2 producer in the US -- began making adjustments long ago, and will have time to move closer to new forms of energy-generation (e.g. "clean coal" technologies strip out CO2 and mercury emissions, which cause acid rain).

The winners under any scenario remain the nuclear and renewable energy leaders, such as FPL Group (FPL) and Exelon (EXC). These remain solid core holdings with solid dividends, and have provided better entry points as the debate -- and the misinformation -- surrounding the bill continues.

As the third quarter begins, the leap-of-faith rally since the March lows will need to be substantiated if the outlook and commentary on the upcoming earnings season is to support it. The real test will be the corporate guidance issued as we enter the second half of the year. Fundamental indicators -- including employment, manufacturing, and consumer sentiment -- and the continued accommodation of the Federal Reserve will be key to the continuation and sustainability of any attempted rally.
No positions in stocks mentioned.

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