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IBD MEETUP/NORTHRIDGE LET’S MEETUP TO DISCUSS SECTOR ANALYSIS FOR 2015, CANDLESTICKS AND REVIEW OUR MARKETWATCH GAME MAR 21, 2015 DISCLAIMER 1. During the course of this meeting we will review stocks that should be considered as additions to your watch list. 2. These are not trade recommendations. These are candidate trades. Do your own research, keep position sizes modest, and stay diversified. 3. Also past performance is no indication of future stock trends. 4. We will also discuss Trading Strategies we believe to be effective; however keep in mind that nothing works100% of the time sothere is no guarantee these strategies will work for you. THE BUSINESS CYCLE A Short Review BUSINESS CYCLES The components of Gross Domestic Product (GDP): consumption spending, physical investment spending, government spending, and net exports. • The pattern of expansion-recessionexpansion-recession that we observe is not random, but built into our system. • Expansions create the conditions that cause recessions and vice versa. BEGINNING THE CYCLE • The business cycle is considered to “begin” as the economy is rebounding from recession. Economic activity begins to pick up, which can be seen through growth in Gross Domestic Product (GDP), reported company profits, and employment. • Businesses can generally keep low inventories and see rapid sales growth during this stage. Additionally, fiscal and monetary policy may still be “stimulative” which provides a further boost to the recovery. • During this phase, the leading economic sectors are those that are more sensitive to changes in interest rates, like consumer discretionary and financial stocks. MOVING THROUGH THE CYCLE • As the economy pushes forward through the initial recovery, growth rates tend to moderate, and the price performance of many stocks may taper off. • This cycle has tended to be the longest phase of the whole cycle, with different sectors having outperformed at different times. Information technology stocks have historically earned strong returns during this phase. • Certain industries within the technology sector, such as software, computers, and peripherals, tend to outperform in particular as other companies are more willing to spend capital and buy their products. As well, companies in the industrials sector are not consistent outperformers, but historically do tend to fare well in these mid-cycle expansions. • The Utilities and Materials sectors can show lackluster performance in these environments, as they tend to lag the broader market. However, since there can often be a lack of clear sector leadership in these environments, investors may want to be extra careful with their sector allocations. TOWARDS THE END • The sustained growth in economic activity will tend to mature and slow towards the end of the economic cycle. • Inflationary pressures may build in these phases, which can lead to outperformance from companies in the Energy and Basic Materials sectors. • As investors begin to see signs of an economic slowdown, defensiveoriented sectors (like healthcare, consumer staples, and utilities) have the potential to outperform the market. • Information technology and consumer discretionary stocks tend to lag the broader market in these environments, as investors shy away from economically sensitive areas. HEADING INTO RECESSION • Recessions, the shortest phase of the business cycle, can be trying for investors. During these periods, credit contracts, sales tend to slow, and it can be difficult for certain businesses—particularly those that are more economically sensitive— to thrive. The broader market lost an average of fourteen percent a year during these periods.1 • Those sectors that are not as sensitive to the broader economic environment can be a bright spot, however. Sectors like Consumer Staples, Utilities, Telecommunication Services, and Healthcare may attract investors. Since they produce items which consumers are unlikely to cut back they have less sensitivity to a decrease in consumer demand than companies in other sectors. • In particular, the Consumer Staples sector has outperformed the broader market during every recessionary period, because businesses in these sectors are comparatively isolated from cyclical changes in demand. Other sectors with similar characteristics—utilities and telecom stocks [high dividend yields]have frequently outperformed when current income is demanded by investors. • There is historic evidence that certain companies in specific sectors show relative outperformance at different times in the business cycle. By understanding how certain companies and sectors react to the business cycle, you may be able to position your portfolio to outperform the rest of the market. • The business cycle is the collection of stages that an economy goes through as it expands, slows down, and declines. These “cycles” repeat, and investors who understand where the economy is situated within the business cycle can better position their portfolios by investing in securities that benefit from the unique characteristics of each stage. SUMMARY BUSINESS & MARKET CYCLES A discussion of where we think they are today SO WHERE IS THE CYCLE AND MARKET TODAY? 10 SECTORS PERFORMANCE VS THE S&P AS OF TUESDAY MARCH 17TH 2015 MARKET FUNDAMENTALS Is the Stock Market Cheap? Consider the S&P P/E RATIO: Mean: 15.53 Median: 14.57 Min: 5.31 (Dec 1917) Max: 123.73 (May 2009) The average P/E ratio since the 1870's has been about 15. But the disconnect between price and TTM earnings during much of 2009 was so extreme that the P/E ratio was in triple digits — as high as the 120s — in the Spring of 2009. In times of critical importance, the conventional P/E ratio often lags the index to the point of being useless as a value indicator. • The current Bull Market is 6+ years old. • Does that mean we are overdue for a major correction? • Going back to the year 1925, data shows that during the typical secular bull market, a 5% price correction occurs every 84 trading days on average. The VIX – Fear Factor – moves inversely to price. SECTOR INVESTING SECTOR INVESTING • One way to invest with the business cycle and diversify an equity portfolio is using sector-based securities and funds. In order to employ this type of strategy, you should know how sectors and industries are comprised. • Different approaches • Thinking of the market in terms of sectors can be advantageous for investors, however, sorting stocks into separate sectors and industries may not be as clear cut as it may seem. • This may be due in part to companies belonging to different industries, depending on the criteria used. • Most classification systems use one of two approaches to sort companies in to industries and sectors; the production oriented approach and the market oriented approach. PRODUCTION ORIENTED APPROACH • The production oriented approach focuses on grouping companies that produce similar products or use similar inputs used in the manufacturing process. • In product oriented approaches, many companies that manufacture products are classified differently than those that provide services, for example. MARKET ORIENTED APPROACH • The market oriented approach focuses on classifying companies by the markets they serve, rather than on the products they produce. In addition to how the company earns revenue, this approach also focuses on how customers use the company’s products. SECTOR CLASSIFICATION STRUCTURES • There are three main classification schemas. They are the Global Industry Classification Standard (GICS), the Industrial Classification Benchmark (ICB), and the Thompson Reuters Business Classification (TRBC). • These classification schemas are designed to provide an acceptable and meaningful method for standardizing industry definitions so that comparison and analysis can be conducted between companies, industries, and sectors worldwide, and for creating benchmarks. Comparison of Major Sector Classification Systems Level/System 1st 2nd 3rd 4th GICS 10 Sectors 24 Industry Groups 68 Industries 154 Sub-Industries *Source: Thompson Reuters, S&P/MSCI, FTSE ICB 10 Industries 19 Supersectors 41 Sectors 114 Subsectors TRBC 10 Economic Sectors 28 Business Sectors 56 Industry Groups 136 Industries • The business cycle influences the rotation of stock market sectors and industry groups. Certain sectors perform better than others during specific phases of the business cycle. Knowing the stage of the business cycle can help investors position themselves in the right sectors and avoid the wrong sectors. • The graph shows the economic cycle in green, the stock market cycle in red and the best performing sectors at the top. The green economic cycle corresponds to the business cycle shown previously. • The centerline is contraction/expansion threshold for the economy. Note the red market cycle leads the business cycle. The market turns up and crosses the centerline before the economic cycle turns. SECTOR ROTATION PREPARING FOR THE TRADING WEEK 1. On weekend, decide what types of trades to be focusing on for the upcoming week (long or short). • Look at the moving averages to determine if the bias is to the long or short side of the market. • Remember that staying in cash (having no positions) and out of the market is a strategy. You do not have to trade! 2. Then its a good idea to get a feel for what will likely affect the market for the week ahead. These are some of the things to look at: • Economic Calendar - To see what types of reports are coming out that could influence the market. • Industry Groups - To see which ones are strong, which are weak, and which ones have potential to make major moves. CHARTS AND SCANS FOR SWING TRADING 3. Charts – To see all the major industry groups on the following charts: • Monthly – Major Trend • Weekly – Intermediate Trend • Daily – Minor Trend • 4 Hour – Use this chart to set up Entry signals. • All above Trends must agree or don’t take the trade. 4. Scans - to find some potential trades. Remember to look for stocks that have pulled back into a potential reversal zone. Stocks that: • are in Stage 2 or Stage 4 of a wave, i.e. Elliot Wave • are in strong trends • have relative strength [RSI above S&P] or weakness [RSI below S&P] • are at a support or resistance level • Are in strong Sectors and are supported by Candlestick reversal patterns Sift through your scan results and find the ones that show these specific characteristics. Add these to your watch list. POSITION SIZING Brief Explanation HOW TO EFFECTIVELY USE CANDLESTICKS A Quick Review CHART CHALLENGE Reading Charts