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Wearing the Rally Cap

equity-put-call-ratio

Back on June 20th [ here is the link: \"You\'re Gonna Need a Bigger Boat\" ], I showed you the above graph and told you that the market would likely be rallying based upon what the graph was telling us. I thought you might like to see what has happened to the market since this indicator flashed a “buy” signal to us so I’ve added the S&P500 Index in pink to this graph so you can see that it bottomed pretty much on schedule with the signal from the indicator.

We went to work and started putting the cash we had generated back into the market with a pretty good success rate. Below is a list of some of the Winners, So/So Performers, and Losers from our work based upon that buy signal (keep in mind that the S&P was +5% during this time):

WINNERS
Eaton: +7.6%
Potash Corp: +7.75%
iShares Timber: +7.2%
Kubota” +6.53%
Trinity: +10.14%
Manitowoc: +11.74%
Monsanto: +13.06%
Magna Int’l: +6.96%
EZ Chip: +7.35%
Emerson: +6.41%
Cummins: +7.82%

So/So
3M: +4.42%
XL: +2.23%
Stryker: 2.11%
Goldcorp: +2.55%
ITT: +2.37%
Komatsu: +3.36%

Losers
Procter & Gambel: -0.95%
Taiwan Semiconductor: -3.79%
ResMed: -0.13%
Boston Beer: -0.11%
Agnico Eagle: -1.31%
Altria: -1.08%

As I review this list, I see some things that are instructive: (1) the more cyclical the company, the bigger the gain, (2) the more defensive the company, the more likely is was to lose money, and (3) the companies that had fallen the hardest during the 7-week pullback in the market rose the most in the rally.

Looking at the graph above, though, you can see that we are clearly in no-mans land. We are neither over-sold nor over-bought on this indicator, so its time to put it to bed and look elsewhere for guidance.

Given that we are heading into earnings season, the fundamentals are likely to take over. What investors will want to see now is that the cyclicals are showing earnings gains during the second quarter – but even more important they will want to see that companies are not cutting expectations for full year earnings based upon a forecast slowdown for the second half of the year.

On Thursday of last week the Chicago Purchasing Managers Index report and on Friday the ISM Manufacturing Index report were released showing that the US is in a slow growth recovery. However, reports from Japan showing strong post-earthquake/tsunami growth and reports from China where the Premier has declared victory over inflation show that international economic growth is likely in the beginning stages. These two things to me mean that US companies that have a strong export business will continue to have growing earnings and that the cyclical stocks have more upside to them (albeit not in a straight line).

With the action in the defensive stocks being so poor during this rally, if we get further upside moves in the cyclicals based upon earnings, look for the Consumer Staples and the Health Care stocks to be used as sources of cash for buyers looking for earnings growth.

For now? We plan to continue to be fully invested at least for the first few weeks of earnings season. If earnings start to come in poorly or companies are providing tepid outlooks, we will book some of the gains above and wait to reinvest them prior to the next rally.


Click Here to Watch today\'s video on You Tube

Mark