View From the Turret: Above the Line
It didn’t take long for the bulls to recover from the recent market shocks…
Regime changes in the Middle East raised supply-side concerns for oil exports. At the same time, emerging market demand continues to support an inflationary environment for housing, agriculture and energy prices. The European debt crisis is like a slow-motion train wreck, and the US is facing employment issues and a spiraling real estate market.
The devastating Japanese earthquake and tsunami raised even more economic uncertainty. Supply chains are in a state of disruption, and the threat of nuclear contamination is still a major issue. All of these risks were enough to push the major equity indices below their 50-day exponential moving averages (EMAs) last week – a truly bearish sign for technical traders.
But true to it’s bullish form, the market shrugged off all fear last week. All major indices found the strength to rally back above the key 50 EMA lines (blue line in the charts below), and the tone has once again turned decidedly bullish.
As a natural result of the price action, our trade book now reflects a more bullish outlook. We hit the exits on the majority of our short exposure last week as profit protective and tightened risk points kicked in. A number of new entries triggered on the long side as well – leaving us with moderate net-long exposure.
Heading into a new week of trading, we are certainly cognizant of the macro risks and how they may affect the global recovery. But with capital rotating back into risk assets, and a number of key groups experiencing bullish rebounds, the trading opportunities are weighted toward the bullish side.
Continue reading to see which areas we are tracking and where we see opportunity setting up for the coming week…
Altenative Energy – Plenty of Room to Run
Energy resources are at the forefront of nearly every global macro trader’s radar today. Supplies from the Middle East are anything but certain. US offshore drilling has ground to a halt after the BP spill, and the government has been very slow to issue renewed permits.
But even though energy supplies are uncertain, developed and emerging market demand continues to grow. This creates the potential for significant spikes in price for traditional energy sources like oil and gas, and demands investment in alternative areas such as wind, solar and geothermal.
Of the proven renewable sources of energy, solar is the area with the most traction and the best investment opportunities. At the same time, solar stocks are undergoing a transformation in terms of trading psychology.
For years, manufacturers along the solar supply chain have been viewed as speculative opportunities. When liquidity was high and bullish traders were on top, solar stocks would advance. But during times of uncertainty and constrained liquidity, solar stocks would slump. The industry closely followed the “risk-on / risk-off” whims of momentum traders.
But more recently, solar has taken on the appearance of a cast-aside industry with low valuations and plenty of room for growth.
Nuclear energy is quickly falling out of favor, and reactors in various stages of approval / build-out are now on hold. Governments are going to have to find alternatives to this power production, and in many cases, solar energy fits the bill.
Most of the established solar manufacturers are trading with earnings multiples from single digits to the low-teens. But the growth opportunity for this industry is tremendous. This is exactly the kind of environment that can launch 100% or 200% or even larger trading moves.
The Mercenary Live Feed has already begun taking positions in a few individual solar opportunities that have begun to establish bullish patterns. If the solar is as big of an opportunity as we expect, the coming weeks should offer us plenty of opportunity to add horizontal and vertical exposure – participating heavily and booking significant profits.
Drill, Baby, Drill!!
As demand for domestic oil and natural gas increases, Exploration and Production companies have more incentive to ramp up drilling programs.
Offshore drilling is a big question mark after the BP spill. Rumors point to new permits being issued, but for now, uncertainty trumps rumors. That leads to plenty of demand for onshore domestic drilling. To a large extent, the industry standard is to contract out this process.
Parker Drilling Co. (PKD) is a strong rebound candidate in the group. Analysts are expecting earnings growth of more than 240% from last year’s depressed level, and the stock is already beginning to reflect the recovery expectations.
From a short-term perspective, PKD looks a bit overbought. But looking at weekly chart, the stock is near the top of a consolidation area from late 2009 / early 2010. Valuation is attractive compared to 2011 and 2012 estimates (this is true across many names in the group), leaving the stock plenty of room once it breaks through resistance.
On the more speculative side, there are several small to mid-cap drilling companies with negative earnings in 2009 and 2010 who are now landing contracts and seeing their business ramp.
These opportunities carry more risk than the well-established drillers with long-term contracts. But if widespread demand for drilling services continues, these stocks could offer much more in terms of risk-adjusted returns.
Heavy global investment in oil and gas properties, along with advancing technology and better transportation methods should continue to stoke demand for natural gas – and in turn demand for drilling.
To Build, or Not to Build
As demand for new homes continues to probe new lows, the prospects for individual home builders look very difficult.
Looking at the price action for the group, there are some mixed signals evolving. On one hand, the homebuilders (as measured by iShares DJ Home Construction – ITB) have broken back above the 50 EMA. Bullish “risk-on” action has propelled a number of sectors as liquidity props up a number of investment areas.
But on the negative side, the action in homebuilders is much weaker than we are seeing in the broad averages. If you look at the charts of major indices above, you will see much stronger action than ITB’s weak rally.
This week we will be waiting for price action to confirm any short entry into the homebuilders group. But considering the bi-polar nature of this market and the number of reversals we have seen just over the last few months, we need to have some bearish opportunities on deck.
Emerging Markets Attract Capital
Last week we noted the mounting economic risks for emerging markets. Issues like widespread inflation, tight supplies of needed resources and vulnerable export-driven economies continue to be significant challenges.
But in the current resilient / rebound environment, large investors are willing to overlook the risks and focus on the opportunities. Last week featured a flood of capital moving back into EM plays – with ETFs covering select countries breaking out of basing patterns.
Like many areas, we are all-too aware of the risks in play, but we also respect the price action – especially considering a market flush with liquidity. Last week we took a position in the iPath MSCI India Index (INP) as the price action broke back above the 20, 50 and even 200 EMA lines.
Subscribers to the Mercenary Live Feed were able to see this trade setup ahead of time and place their orders before the open on Thursday. We entered the trade at $68.31 and are already approaching an area where we can begin to take risk off the table and begin thinking about locking in profits.
A couple of hours before trading begins, futures are pointing to a flat open. We’re locked and loaded with a full slate of opportunity and a handful of strong positions already in the works.
Trade ‘em well this week!