Navarro's Broad Market Outlook: A No-Profit Rally

I'll be brief this week as Matt has generated lots of good food for thought below: There's much ado about the current rally, but it is not exactly a rally that it is very easy to make money in - propelled as it is in many ways by energy and housing stocks that, at least in my view, are too speculative to hug the long side on.

What I found most interesting this week was the Bearish Chorus among the aging Bulls that Barron's trots out every six months to take the pulse of the market.   Almost all of these New York-centric button-downs see slow growth ahead for the U.S. economy as it is being steadily worn down by rising rates and high oil prices.  Hey, sometimes, even they are right.

This Week's Market Movers

It's a pretty quiet week in Lake Woebegone - and on Wall Street.  We'll see some new data on new and existing home sales but you should expect the current robust patterns to continue as we move into the middle of the summer buying season.  Other than that, there's only durable goods to provide some clues - but this report is too volatile to ever take seriously.

Portfolio Musing

I always know when the market is ugly when sound technical plays fizzle out rather than following through.  That's what happened for me with ADSX, which I dumped before it could get costly.

As for Chiron (CHIR), which I'm holding 2007 45 buck calls on, it didn't help my cause that the company announced lower production targets for flu vaccine for next year.   But that's why I always get LEAPs way out in time - so I don't have to worry about it.

Hedging Your Bets With Matt Davio: Toil and Trouble

Volatility dipped to new 14-year lows this week, as we went into the “triple witch” options expiration of this June - the concurrent expirations of  stock options, stock index futures, and options on stock index futures that happens four times annually, on the calendar.

With volatility levels this low, my eyes continue to focus on the new paradigm “four horsemen” stocks:  Google (GOOG); Chicago Mercantile Exchange (CME); homebuilder and mortgage company NVR Inc. (NVR), and Sears Holdings (SHLD). 

“Four horsemen” is a term first coined in the late 90's by Mad Money's Jim Cramer, former head of the Cramer/Berkowitz hedge fund.  He used it to categorize the former paradigm stocks of  Intel, Yahoo, Cisco, and Microsoft.

Today's four horsemen are GOOG, CME, NVR and SHLD make up the new hot sectors of the market.   Google is the upstart latest-mania-IPO from last summer.  The Chicago Mercantile Exchange represents the last four years of upside in commodities and their trading markets.  NVR covers the homebuilder/mortgage beat.  Sears Holdings is a  product of the latest Retail merger of Eddie Lampert and his ESL Investments, Hedge Fund.

These stocks remain important to the current two-plus year rally we started in March of 03 in that they represent sectors and businesses that have benefited from the low interest rate environment that Greenspan created for the U.S. economy. The other key point to these stocks is that the fast/smart/retail/index money/institutional - okay, almost all market money - is chasing these high multiple fliers, which all happen to trade at price tags of at least $150 a share.  Apparent volatility tends to be greater in these names due to the high price tags.

GOOG currently trade in the 270's, NVR in the $800's per share, SHLD @ 150's, and finally CME trades in the 250's.  Each of these stocks represent the easy or fast money, in my opinion. 

Punch Line #1: As long as they stay in their uptrend, my guess is that we will remain in a bull cycle within a longer-term Bear Market. 

Now let's take a look at one of the strongest stock groups where NVR Inc. resides - the home-builders - of which almost all have been rising, if not surging.  I follow seven of the leading home-building stocks, and each one has been rallying.  Yet only one of these stocks pays a dividend of as much as one percent.  That means, if you buy a home-building stock, you must hope that it will rise.  Otherwise, if it stalls or if it declines, you have no reason to hold it - it pays you nothing, and the only thing you'll gain is losses.  Let me demonstrate. Below are some leading home building stocks and their dividend yields:

NVR (NVR Inc.) @0 yield.
KBH (KB Homes) dividend yield 1.08%.
CTX (Centex) at 0.23% yield.
LEN (Lennar Corp.) at 0.91%.
PHM (Pulte Group) at 0.25%.
RYL (Ryland Group) at 0.34%.
TOL (Toll Bros.) at 0 yield.
BZH (Beaser Homes) at 0.75%.

What does this tell us about the markets today?   To me, it says that easy money is the key theme here.  This easy money is driven by the low interest rates that the Fed has provided us since 2000, which has provided for the growth in homebuilders and equity refugees.  

Also, easy money has been made in Retail stocks as Americans continue to buy, buy, buy.  SHLD is actually a composite Real Estate play with the merger of Sears and Kmart, so that can also be considered a RE play. 

Finally, Commodities have enjoyed a nice five-year run up in prices, which can be reflected in the Chicago Mercantile Exchange.  GOOG is the latest on cutting edge technology, just like we had Iomega in the 90's, Netscape, AOL... all before the original “four horsemen.” 

Punch Line #2: I believe you need to carefully watch these names to see when the actual shift occurs in the easy money.  As interest rates rise, all “four horsemen” should begin to fall, and we will then look for leadership in the next paradigm. 

Below I have posted the charts of all four stocks, and I believe the key thing to focus on is that all of the charts are weekly in nature and show clear up-trends.  Until these trends are broken, they will remain the “fast money” names.  What will take them down, I can't tell you.  But they can go up - typically longer and farther than anyone can imagine today. 

I do happen to believe every name shown is a speculative name, as not one of them provides a rental payment or dividend for holding the stock.  So its pure speculation if you want to play and own these four names. 

NVR remains in an uptrend above 700. CME remains in a long term uptrend above and around 180-190.  SHLD remains locked upward above 105 or so.  Finally, GOOG the youngest of the bunch in the stock world, remains upward as long as it stays above a 180 price range. 

These stocks are names that intrigue us in our Red Rock Capital Fund - and form another measure of market temperature.  These stocks seem scary to me, and regularly need to be updated and gauged for market temperature and emotion.  But it is very important in all cycles of all markets to understand who and why your leaders are what they are, before making investment/trading decisions. 

Peter Navarro is a business professor at the University of California-Irvine (www.peternavarro.com).  Matt Davio is a managing partner at the hedge fund, Infinium Partners, and be contacted for hedge fund services at infinium@peternavarro.com.

DISCLAIMER: This newsletter is written for educational purposes only.  By no means do any of its contents recommend, advocate or urge the buying, selling, or holding of any financial instrument whatsoever.  Trading and investing involves high levels of risk.  The authors express personal opinions and will not assume any responsibility whatsoever for the actions of the reader.  The authors may or may not have positions in the financial instruments discussed in this newsletter.  Future results can be dramatically different from the opinions expressed herein.  Past performance does not guarantee future performance.