A Few Winners, Losers and Swing Trade Opportunities

Bio-Techs

We wrote a note a few weeks ago saying that we were moving into the bio-tech space for a few reasons, seasonality and favorable chart patterns the two main reasons (Biotech's Getting Ready to Break-Out).

This past week we saw the bio-tech ETF (IBB) break above $300 and we decided to build a position. We decided to buy Direxion Daily S&P Biotech Bull 3X ETF (LABU) @ $56.55. We are sitting on 27% profits and will hold to see a pull-back and support. Any support above $55 will entice us to further increase our position.

From Business Insider, “The Nasdaq Biotechnology Index (NBI) surged 9.2% over the five days, its biggest increase since the week of the election. Portola Pharmaceuticals and Clovis Oncology led the charge for the 162-company gauge, both climbing more than 55%.

In addition, an exchange-traded fund tracking the gauge absorbed more than $700 million during the three days ended Friday, the biggest inflow since early November for a period of that length.”

“While a significant portion of post-election stock market gains have resulted from optimism around proposed political policies, biotech drove returns the old-fashioned way: by getting good news.

According to recent reports from Kaiser Health News and Politico, the Trump administration is preparing an   executive order that's shaping up to be favorable to drug companies. On Tuesday, The New York Times reported on the contents of a draft of the executive order, reaffirming the administration's likely more relaxed, industry-friendly stance on drug pricing.

That marks a stark departure from the anti-drugmaker rhetoric floated by Donald Trump in recent months, with the president even going as far as to say back in January that biotech companies are "getting away with murder."

It's the latest twist and turn for biotech stocks, which have been taken for a wild ride since the election. The NBI rose a whopping 12% in the week following November 8 amid expectations that Trump would have a positive effect on the group, which was blasted by Hillary Clinton on multiple occasions on the campaign trail.

But it wasn't that simple, as Trump made comments over time that led investors to believe that he too was targeting drugmakers. For instance, on March 21 said that he wanted to slip drug pricing into the GOP Obamacare replacement plan. The NBI dropped 2.8% that day.

While the future for drugmakers may have looked bleak at times, the recent surge in index was actually foreshadowed by options traders. As of May 18, they were paying the lowest premium since October 2013 to protect against losses in the NBI, relative to hedges on the S&P 500, Bloomberg data show. That's an extremely bullish signal. 

Now that things have been looking up for biotech, investors are starting to pay a higher premium to protect gains.”

“Beyond the recent news flow, investors may also be buying biotech shares in preparation for the earnings recovery the sector is expected to enjoy in the second half of the year.

Drugmakers will grow profits by 5.7% in the fourth quarter, lifting its full-year 2017 earnings expansion to 4.8%, according to estimates compiled by Bloomberg. While that will lag the broader S&P 500, it's a welcome sign for an industry just finding its legs again after some turbulence.”

Energy

Back in May we decided to take a few positions in the Energy sector. This trade turned out to be a mess with oil prices entering bear market conditions and energy names suffering greatly because of it (Looking at a Few Trades in the Energy Sector).

Brent crude prices are approaching the 50% Fibonacci retracement from the early 2016 lows. The green shaded area in the chart below could act as some support.

That said, we do not have high hopes of this sector rebounding anytime soon and we’ll probably cut our losses if XLE breaks $62.50 to the downside.

From Business Insider, “There aren't enough buyers for the oil available in the world.

Last November, the Organization of Petroleum Exporting Countries tried to solve this by agreeing to lower production. But this was not enough, and Libya, Nigeria and Iran — three members that weren't part of the agreement — have raised their production.

So have US shale-oil producers, who this week extended a record-long streak of adding drilling rigs.

And so, the supply side failed to avert a 4% slide in oil prices this week to the cheapest levels since OPEC agreed to cut output in November.

Strategists at Bank of America Merrill Lynch are skeptical that higher demand would be the solution.

"It is hard not to notice some cyclical red flags" that risk counteracting higher oil prices, said Sabine Schels, a commodity strategist, in a note with colleagues on Friday. 

"While most investors blame supply for today's low oil prices, demand has also failed to improve at the speed required to rebalance the global oil market. Looking into 2H17, we now doubt that demand growth will accelerate sufficiently and see downside risks to our forecasts of 1.3 million b/d in both 2H17 and 2018. In the absence of a mirroring supply response, softer consumption could push 2018 balances into surplus. Put differently, demand will not break the current downward price momentum for now."

Any takers? 

Oil demand in the first quarter slowed and was weaker than expected, Schels said, after examining demand growth by region.

The strategists initially pointed to a number of temporary factors like a warmer-than-usual winter in the US and India's decision to void the highest denominations of its currency. But as demand weakness extended into the second quarter, it became clear that these weren't the only reasons. 

Worse still, Schels said, is that the demand weakness is spreading to markets that are usually strong including the US and China. "This suggests that cyclical, rather than solely transient, factors are perhaps also at play here."” 

“Beyond that, the global economic picture doesn't suggest that countries are going to be demanding more oil soon.

"Clearly, the uncertainty around tax reform has started to dampen sentiment and confidence, with negative consequences for investment and hiring decisions," Schels said. "In Asia Pacific and Japan, economic data and inflation has also started to roll over. In Latin America, the situation in Brazil is u nstable leading us to halve our GDP growth expectations for next year to 1 .5 %."

China provides the clearest example of a cyclical slowdown, Schels said, amid a softening in industrial production and electricity generation. 

BofAML forecasts a slowdown in China's economic growth and thinks that could lead to a slowdown in imports of crude oil.”

“Central banks could also be complicit in keeping oil demand by forging ahead with raising interest rates. Schels noted that it becomes harder to finance consumption of oil when interest rates rise. Also, if higher rates lead to a stronger dollar, emerging-market countries that are big consumers of energy products could face higher costs. 

"Tighter money at a time of weaker activity poses deflationary risks and spillover to the real economy," Schels wrote. “

Gasoline

Gasoline prices are rolling over. The commodity broke through support near $1.45 on higher volume. The next level of support looks to be near $1.28. This represents another 10% to the downside. United States Gasoline (UGA) ETF is thinly traded but offers an opportunity to capitalize on the weakness. I’m not sure if there is an opportunity to short this ETF but I noticed that it does trade options. I may pull the trigger and purchase some put options if there is adequate liquidity.

I’m not sure yet how to participate to the downside (as I don’t trade gasoline futures) but I’ll be doing some research this coming week to see if there’s a way to make money with this trade. Preferably we’d like to see a bit of strength in the commodity and a failure to recapture support.

Defensive Sector Trades

Defensive sectors appear to be in play. The chart below depicts the PowerShares S&P 500 High Beta ETF (SPHB) against the PowerShares S&P 500 Low Volatility ETF (SPLV). The trend clearly favors lower volatility defensive stocks. The high beta portfolio is trading below its 50-day EMA while the low vol ETF is solidly above its 50-day EMA.

Since the Trump rally started to lose steam back in February/March we are seeing trends that the market is taking a more cautionary stance towards the economy.

We’re seeing additional evidence of this skepticism with the aggressive flattening of the yield curve of late. The steepening of the yield curve that happened post-election has now retraced back to where it was prior to President Trump being elected. As long as this economic skepticism remains in place, we will expect the low volatility defensive stocks to outperform the higher beta names.

Health Care has exploded this week. This is good for us as we build a value position in the sector (XLV) back in November in the $68 range. Like the bio-tech trade, we’ll wait for a pull-back and see where support settles in and most likely add to our positions.

Consumer Staples

The consumer staples sector is not cheap by any means but we believe it could offer a nice shorter-term swing trade opportunity. From the chart below we are seeing a solid bullish trend in the sector as depicted by several of its exponential moving averages. The Consumer Staples Select Sector SPDR ETF (XLP) has dropped to its 50-day moving average that provided support earlier in the year. It is also sitting near support from its breakout point.

Also note that the RSI (30) has consistently remained above 50 for the year and the RSI (5) is under 30 (oversold). This oversold situation in a larger uptrend has offered several short-term trading opportunities in the past.

Since 1998, there have been only been roughly 50 trading opportunities out of over 4600 observations (1.7% of the time) where the RSI (30) was above 50 and the RSI (5) was below 30. The two, three, four and five day returns upon this occurrence have been exceptional, offering annualized returns in excess of 30% vs. roughly 5% when this condition is not in place. These swing trades have been profitable nearly 70% of the time.

For those looking for a swing trade opportunity this is as good a set-up that we can find in these market conditions.

In the graphic below, I have provided the near-term return profile for XLP when this RSI condition has been met. All-in-all I like the risk/reward profile of this trade.

Utilities

Another defensive sector that had broken out is the utilities sector. Similar to the consumer staples sector, it too has an RSI (30) above 50 and an RSI (5) below 30. This is a rare occurrence and has led to near-term sector outperformance. While I ran the back test for return results, I’m just not a buyer of utilities now and rather keep assets deployed in the health care, bio-tech and consumer staples sectors.

Joseph S. Kalinowski, CFA

Email: joe@squaredconcept.net

Twitter: @jskalinowski

Facebook: https://www.facebook.com/JoeKalinowskiCFA/
Blog: http://squaredconcept.blogspot.com/
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