Mind the Doors, Please. The Doors Are Closing.
The old saying about a window opening every time a door gets closed is ringing loud and clear today.
For those willing to listen…
According to our best figuring, the market is currently scraping along the bottom of this latest correction, riding the its rising long-term moving average and awaiting more buyers to join the caravan (see chart below).
In the meantime, even though we’re still experiencing some selling, our best advice to all is to act sooner rather than later in taking on new positions.
When the selling finally concludes, we believe the subsequent lift on the indexes will be akin to the cockpit pressure of an SR-71 Blackbird disengaging from earth and winding its way heavenward.
To that end, we want to take a moment to emphasize the need to be in to win.
That is, we expect that over the next few weeks you’ll be hearing a great many dire warnings about holding equities, the wretched state of the economy, the dangers of the fiscal cliff, the mountainous burden of taxes soon to face investors, and all precisely at a time when you should be considering opening up your wallet and taking on new, substantial positions in equities.
Have a look here:
We’re pleased to report that our worst-case, downside target has now been reached for the Dow.
If you remember, our call for this correction predicted a retreat to the long term (411 day) moving average (in yellow) before any bump higher was possible.
We’re now at that level, but we warn that we could see a dance about that line of support for what might seem an eternity. We do not expect closes to fall far below that support, however, and more than one day’s disconnect from the 411 day moving average would certainly prompt us to re-examine our thinking.
As for RSI and MACD indicators, neither is showing a great deal of promise at this point, though in fairness, they rarely do right before a bottom. RSI has turned up slightly, and should it continue to do so we’ll be looking for a MACD cross higher before we order in pizza and dancing bears.
In the meantime, we’re also encouraged by overall sentiment levels issuing from the American Association of Individual Investors (AAII), which looked like this at the end of last week:
At 28.82% bulls, things look relatively grim, but we’re always ready to accommodate a wholesale depression from the folks at AAII in our search for indications of a pinpoint market bottom.
We also like what we see from the following chart, which measures the distance of the S&P from its 50 day moving average:
As you can see, the S&P 500 is now deeply oversold, having dropped more than two standard deviations below its 50 day moving average.
These are the kinds of readings we get before abrupt turns in the market, similar to what we had mid-summer before the S&P 500 climbed almost 16% into September.
That, of course, speaks to the index as a whole. But the subsector that has done the greatest bleeding, falling far more than the rest of her comrades by a longshot, is the utilities, which have already logged a decline in excess of 12% since her top was put in on the first trading day back in August.
Have a look here:
The fallout from hurricane Sandy was adversely felt by investors in all east coast utilities, and the Dow Utilities Average took an obvious hit from that event (red box). But we note, too, the deeply oversold readings from the RSI (blue box), which, at sub-20, is normally indicative of a sector’s readiness to bounce higher – if not make a wholesale change in trend.
We’d normally wait to see a cross higher from the MACD indicator at this point before opening a speculative long position. But this time we’re not waiting for that.
We are going to pre-empt the signal, catch the falling knife, assume the risk, dive in and monitor the situation like a hawk.
The utilities are the worst performing sector on the year vis-à-vis the broad market (see chart below). But they’re also the highest yielding.
We’ve selected from among the finest utilities in the land for our next trade, which goes like this.
We are buying shares of Unitil Corporation (NYSE:UTL), a utility operating in Northern New England that’s been dragged lower with the sector and is ready to bounce.
UTL yields 5.64% annually, trades at a multiple of 14x last year’s earnings and 1.4x book value. Its chart shows it also got wham-doggied when Sandy blew through.
UTL is now trading at $24.45, and we believe we can take three dollars out of the trade – plus dividends – in fairly short order.
Trade #2: Arch Coal (NYSE:ACI) Needs More Options Sold
We spoke last week about the likelihood of our rewriting the ACI covered CALL trade, which we initiated back on the 15th of October in Wall Street Elite Trade Roundup. At that time, we bought the stock and sold the November $8 CALLS, reducing our cost for the shares to a base level $7.09.
We’re now following up by selling the January expiry – again the $8 strike. The CALLS are selling today for 30 cents. We’re selling one CALL for every hundred shares we purchased, thereby bringing our adjusted cost base down to just $6.79 per share. Add another $0.03 per share from the November dividend and your new base is $6.76.
As ACI has dropped recently to – along with the entire coal sector – this options sale should help recover some of the loss.
The chart shows inimitable signs of a bullish move off the July lows. From $5.16, ACI climbed to just under $9 in late October, zigging and zagging in textbook technical fashion, making higher lows and higher highs along the way (red circles at top). This pattern is quintessentially bullish.
Today, the stock has retreated to $6.59. So long as it stays above the $6.00 mark – the point at which the last retracement bottom was struck – we’ll remain in bull mode.
The next few days should be decisive. We see the RSI indicator trending below its waterline, but moving higher. In itself, this is not indicative of anything, though if it continues upward and surfaces, we’ll have more confidence in the bullish scenario continuing.
The MACD indicator is not yet fully submerged below its waterline (the trailing MA has yet to splash down), giving us another wisp of hope that current levels will hold.
Wall Street Elite recommends 1) selling another round of CALLS (January 8 strike) on your ACI position, and 2) making a speculative purchase of UTL shares at the market.
With kind regards,
Hugh L. O’Haynew