View From the Turret: The Trend Continues

March 18, 2012
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After a brief diversion early this month, the bullish trend has re-asserted itself with the major indices once again hitting new 3-year highs and speculative growth stocks catching a bid.

The US consumer appears to be alive and well, as evidenced by Apple once again selling out of its newest version of the iPad, and the company’s stock now up 45% for the year.  Homebuilder stocks are hitting prices not seen since 2008, and luxury retailers from Lululemon Athletica (LULU) to Harley Davidson (HOG) are well into multi-year bull trends.

At times like this, it’s easy to throw caution to the wind and simply “buy stuff”…  After all, when the trend is bullish you have to be on board right?

Today’s bullish trend is certainly a powerful tailwind, and as traders we always respect the price action.  But rather than buying blindly, we need to be particularly picky when it comes to what long exposure we will add to our trading book.

Buying extended names that are hitting new highs, introduces too much risk into the equation.  It’s just too difficult to determine where proper risk points should be placed.  With a stock like HOG, we could easily see a 10% pullback without damaging the technical picture – and if you use a tighter risk point, you could get stopped out while the overall trend is still very much in play.

As we head into a new week of trading, we’re focused on isolating bullish patterns that are NOT extended on the weekly charts – giving us a chance to buy into sectors that are in the early stages of bullish trends – and have reasonable risk points and plenty of runway for future gains.

At the same time, there are a few isolated bearish sectors we are interested in.  These are areas that face specific geopolitical or regulatory risks, and have already demonstrated bearish characteristics (despite the broad market moving higher).

Having a relatively balanced approach to our book (while still keeping more capital at work in bullish trends) helps to smooth out the P&L curve, and gives us some insurance should the broad picture begin to deteriorate.

Below are a few of the areas we are focusing on this week…

Drilling For Black Gold (And Gas…)

As crude prices continue to hover well over $100 per barrel, the incentive to drill becomes more and more appealing.  Last week, the Mercenary Live Feed added a handful of E&P (Exploration & Production) stocks to our roster as continuation patterns gave us attractive entry points with acceptable risk envelopes.

TransOcean Ltd (RIG) is one that bolted sharply higher shortly after our entry, gapping to a new 2012 high on Friday after issuing an update on its drilling fleet.  According to a recent report by Global Hunter Securities – as published in Barron’s Online, RIG enjoys a competitive advantage as pricing increases – due to having a larger percentage of its fleet available for higher-priced new contracts

From the report:

In our weekly Monday note we ran sensitivities highlighting which offshore drillers have the highest leverage to rig-repricing opportunities in what should continue to be an upward trending dayrate environment. With roughly 61% of its available rig days contracted in 2012 and 37% in 2013, Transocean has more leverage than any of its peers.

~Transocean Shares Could Hit $70 – Barron’s

This week, we will be able to adjust our risk point on this new position to breakeven – cutting out the risk t initial capital, while still giving us plenty of room for additional profits.

Cimarex Energy (XEC) looks like it could have a similar run, after trading sharply higher in February, and then spending a few weeks consolidating its gains.  With solid prospects for 2012, and 27% expected EPS growth in 2013, institutional buy programs should continue to push this E&P stock higher – and the “thrust and drift” pattern creates a great opportunity for a trend position with limited risk.


Shippers Rebound From Deep Base

If you pull up a 10-year weekly chart of almost any dry-bulk shipper, you’ll see a picture of true carnage.  The group was devastated by a sharp decline in day rates – and even the shippers who had secured long-term contracts had to deal with bankruptcies or distressed re-negotiations of terms.

The majority of losses occurred in late 2008, but the shippers had another sharp downdraft late last year as European demand fears led to another round of panicked selling.

That final round of liquidation set the stage for what very well could turn out to be a long-term bullish trend for shippers.  The last weak holders have now been shaken out – and sentiment has plenty of room for a bullish shift.

Diana Shipping (DSX) looks particularly interesting after bottoming in October.  Incidentally, the low in October 2011 briefly took out the previous low from November 2008.  Taking out this long-term low should have been effective in knocking out investors with ANY reservations about owning this stock – which now gives DSX a chance to rebound with only the strong hands holding long-term positions.

The stock rallied sharply in February and then pulled back to test its breakout point.  A push higher late last week confirms the stocks strength – and also sets up a series of higher lows and higher highs (exactly the pattern that a bullish trend follower wants to see).

Education & Airlines Under Pressure

The two areas offering the best bearish setups at this point are for-profit education stocks, and US airline companies.

It’s easy to see why the airlines are struggling.  Higher oil prices mean rising fuel costs.  Most of the airlines have hedging programs in place to help smooth out prices for the short-term.

But as oil prices linger above $100 per barrel, and economists adjust their long-term models, airlines are beginning to enter hedges at much higher prices – locking in fuel costs that crimp future margins.

Depending on the strength of the US consumer, the airlines may be able to ratchet up prices to help offset these rising costs.  But considering the ultra-competitive state of the industry, raising prices too early can simply result in fewer seats filled and lost revenue.

After rebounding with the broad market for the last 6-9 months, airlines are now turning tail and setting up bearish patterns.  A swift rebound last Thursday was met by intense selling Friday.  The headfake sets up a great short entry as “trapped” short-term buyers from Thursday are now likely to throw in the towel as the airlines hit new lows.

With earnings season still a few weeks away, and the Fed meeting in the rear-view mirror, there shouldn’t be too many catalysts to disrupt the current trend.

Don’t let your “intuition” talk you out of what the charts are clearly signaling.  We are in a bull market for the time being, and our best indicator for when this changes will be the price action itself.

It makes sense to balance exposure, to manage risk, to develop scenarios for when the season changes – but until that point, it’s important to take advantage of the broad tail wind.

Trade ‘em well this week!
MM


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