Wonderful World of Mid-Caps (MTD,IWR,DBC,XLE)
Well, we’ve waited… and waited… and waited….
We’re patient people, after all. So it doesn’t kill us to bide our time.
But we have to admit that it’s getting a little ridiculous.
As of the latest data, the NASDAQ market has set an all-time record number of new highs in a calendar year at 63.
Have a look –
The last time we got a reading this high was back in 1980.
That’s almost 40 years.
But not only have we seen relentless buying on the part of investors over the year; we also have a situation of persistent calm during the entire rise!
That’s right – no choppy waters, no heaving tides.
Just this –
Try to comprehend this: we’ve now gone a whopping 43 days without so much as a half percent pullback!
And that, too, is a wonder.
And it makes us wonder…
If perhaps our patience and all this calm is actually foreshadowing a wild, fiery frenzy of a downdraft that almost inevitably follows such tepid weather.
Could it be…?
If you’ve been following our commentary for the last few weeks, you’ll remember that current VIX readings are also pointing to a near term spike in volatility, and we believe the time is now ripe to place our wager on it actually coming to pass.
But before we get to it, let’s take one more look at those aforementioned silky-smooth 43 days through a slightly more interesting lens.
The chart below is a paste-up of three separate indexes, the Dow Jones Industrial Average, representing some of the country’s largest and popular mega-cap names, the iShares Russell Mid-Cap ETF (NYSE:IWR), and the iShares S&P Small Cap 600 Index ETF (NYSE:IJR).
And the trend is clear.
As the Dow was climbing to ever new highs, gaining better than 3.5%, the smaller capitalized issues were turning lower. The small-cap runts took it hardest, retreating 2.5% over the period, while the midcaps began flat-lining about half way along, turning down only slightly during the last week.
And what does it all mean?
Well, this is precisely the kind of action we see prior to a corrective event of the sort that we – and the rest of Wall Street – have been expecting for some months now.
It’s a recognizable pattern.
And it’s the mid-cap stocks, in particular, that would interest us in the case of a significant drawdown.
Well, let’s first take a look at a longer term picture of the IWR mid-cap index.
Below is two years’ worth of daily chart action, and it clearly shows that the technical picture has deteriorated. After a strong 43% rise since the February 2016 bottom, we appear to have hit a significant snag.
Take a look –
After the completion of a three fan-line pattern, it appears IWR is preparing to turn over. We would have to see a strong move toward $205 to believe the current rise still has legs. But even with that action, it’s unlikely there’d be significantly more upside until we saw a meaningful retreat.
As to the size of that retreat, the simple Fibonacci retracement calculation brings the mid-caps to either 165 or 177.
Two Trades to Report, Then the Wonder Begins
Our first initiative was opened on January 17th in a letter called Commodity Resurrection. There, we urged you to purchase the DBC April 16 CALL for $0.65 and sell the DBC April 16 PUT for $0.60. Total debit on the trade was $0.05.
The CALL subsequently expired worthless, but in our April 4th letter we saw the necessity to roll out the PUT to May 16th, adding another nickel to our initial debit.
And alas, it didn’t help. We bought the shares for $16 when the PUT expired in-the-money and have held them until today.
DBC now sells for $16.40, and because the rise has been so steep off the $13.75 bottom, we say the time is ripe to move. Dump it and you pull in $0.30 on $0.10 spent, a 300% profit.
And it’ll have to do.
Next up is our September 19th trade from a letter titled The Snowball Manifesto that recommended you purchase the XLE January 18th (2019) 75 CALL for $1.95 and sell the XLE January 18th (2019) 55 PUT for $2.05. Total credit on the trade was $0.10.
And today? The call goes for $3.15 and the put for $1.77. Sell the former and buy back the latter and you shake out $1.48 on not a penny expended. Adjusted for minimal commissions gives you a return of 887%.
And a big Cheshire cat grin.
This Week We’re in Toledo!
The trade we alluded to above is a pairing involving the broad mid-cap index and a mid-cap stock which we believe has now danced its last.
The company is called Mettler Toledo International Inc. (NYSE:MTD), it makes machines for a variety of applications in the health care, retail and other fields, and the stock is 98% institutionally held.
The daily chart looks like this –
Bottom line here is we have a breakdown that has sent RSI below its waterline (in green) and MACD poised to follow in the days ahead. That would offer the bears an excellent reason to dump the stock. Particularly because the existing trend channel has been breached on rising volume.
But Not Only That!
Look now at the weekly chart, that shows two very bearish developments –
The worst is that we have two weekly RSI overbought readings in the last six months (in green) – a development that almost always leads to a decline. Second, we have a bearish engulfing pattern (blown up in red), that is also a reliable harbinger of a substantial decline in the making.
Now look at the monthly –
Here, the picture is eerily similar. A long overbought MONTHLY RSI condition (in green) and a monthly bearish engulfing pattern!
It doesn’t get any more technically bearish, friends.
That’s why we’re going long/short with it against the mid-cap sector.- Content protected for Normandy Executive Lounge, Wall Street Elite, Executive Lounge members only]
Options Trader Elite recommends you buy the IWR May 18th 210 CALL for $3.10 and sell the MTD April 20th 730 CALL for $3.30.- Content protected for Normandy Executive Lounge, Wall Street Elite, Executive Lounge members only]
IWR now trades at $200.56, MTD at $622.66.
Many happy returns,