Stand aside! Gang way! Look out below! Timberrrrr!
The decibel level toward the end of last week got so shrill that we had to throw on the headphones and cool out to some chug-a-luggin’ Johnny Cash tunes just to get some perspective.
Heaven help us – you’d think the very planet was living out its last days!
But as Johnny says,
I keep my eyes wide open all the time…
In fact, while all the major averages and a few headline stocks were putting straws to the gravy, a few select sectors were actually performing well. And not just the usual suspects, like the utilities.
This, for illustration sake, is the Dow Jones Utility Average for the last six months, matched against the Industrials (DJIA) for the same period.
The utilities, of course, are the investment refuge of widows and orphans – a good, safe place to park funds and collect income regardless of the market weather. Or, at least, that’s the role they’ve played historically.
But in a world of increasing fanaticism and natural disasters, where power plants and pipelines and refineries have become ‘military’ targets, and explosions and meltdowns kill and maim thousands and pollute air and water for decades ever after, who knows if the weakest in our society will inevitably turn to this sector for their financial salvation.
In the meantime, they were a better place to be last week than the Industrials. The Dow sank nearly 2000 points over the last five sessions, 3000 if you go back to the beginning of the decline in mid-May.
Yesterday’s action was particularly grim, with a better than 1000 point drop at the open that ‘bounced’ higher to leave just a 588 point rout by day’s end.
That was enough to get everyone nodding that we had a ‘correction’ on our hands, whatever that definition offers.
So is it all over?
Bottom line from our vantage point is like this – it’s a garden variety pullback in an ongoing bull market, and we’re not yet ready to throw in the towel.
Signs of a pending meltdown we don’t see. In fact, as we perused the market landscape over the weekend we came across numerous quarters of unlikely strength, among them the homebuilders.
And we thought: what a bizarre truth it would be if the very sector responsible for the last great market disintegration were to be turning a corner today, precisely as the rest of the investment world fell down and went boom.
For remember, it was the sub-prime mortgage fiasco of 2007-08 that landed us in our last cauldron of boiling broth, from which we’ve since recovered, of course, with the assistance of meddlesome governments the world over.
So you’re buying the homebuilders?
Before we address that, and offer our trade for the week, just one more word about the current tidal selloff.
First up, the technical damage done to the markets over the last week has been severe, to be sure. There’s no gainsaying a market that crashes through all its moving averages; it’s simply a bad development. As we write, it’s a daunting 1300 point climb just to put her back in the bullish ball game.
Emerging Markets, too, have been crushed, with China and Brazil both getting creamed. It’s still unclear if the carnage in those markets is complete.
Connected to that, commodities are just plain rotting.
A look at the chart below of the Bloomberg Commodity Index shows the damage done of late to that asset class.
We are now at price levels not yet seen in the 21st century, with better than 60% losses across the board since highs were struck in 2008, a full 20% of them coming this year.
And it’s a self-feeding loop.
As the demand for commodities abates in emerging markets like China (where the vast majority of new demand originates), those currencies get flogged mercilessly by investors. That strengthens the dollar, which in turn, delivers a second sucker-punch to commodities, as the trade in raw materials is conducted in U.S. Dollars. Higher dollar equals sinking commodities. And the cycle repeats.
Signs of Hope
All that aside, we have to acknowledge several important indications that the bloodletting may be close to over, if not yet fully complete.
- The first is an oversold reading for the RSI indicator on all three major market averages,
- Second is the deep decline and strong bounce off yesterday’s bottom, also indicative of at least a short term counter-trend trading opportunity,
- VIX also spiked in Herculean fashion, rising suddenly to better than 53 before backing off at day’s end to just 40.74. That’s her highest reading since 2011 and well within range of VIX selloff tops over the last decade,
- And finally, we saw almost no evidence of a safe haven flight to Treasuries, a development that indicates little commitment to the selloff being a long standing affair.
The long and the short of it is we’re not going to recommend you jump back on the stock buying express at this stage, as anything could still happen, and it wouldn’t be wise to attempt to call a bottom here.
What we are happy to do, however, is urge you to nibble on certain selected corners of the market.
As we mentioned earlier – today, it’s the homebuilders.
This is the way they’ve fared during the latest shakeout.
This is six months worth of the SPDR S&P Homebuilders ETF (NYSE:XHB), among the more popular of the builder ETFs.
And what does it show us?
First of all, we’re a mere ten percent off the highs (after retreating over 20%, peak to trough). Second, all the damage was done in exactly two trading sessions! That’s phenomenal. Particularly when compared to the Dow’s sixteen percent drop over three months.
In short, the panic was on for the homebuilders, despite the best industry sentiment readings in a decade (see below), and we say the vast majority of the pain has already been undone. In our view, this puppy is on a fast track to recovery and should be at new highs within a month.
For that reason, we’re recommending selling PUTs for premium, the details of which look like this –
Wall Street Elite recommends you sell the XHB September 35 PUT for $0.73.
We’ll be very happy to own the stock for $34.27 if it closes below strike at expiry.
With kind regards,
Hugh L. O’Haynew, Captain of the Derivative