09/03/08   Is Consumer Discretionary Strength Real?

Editor’s Corner

Is Consumer Discretionary Strength Real?

Ron Rowland

Gustav left oil and gas facilities with little damage for the most part, but the hurricane season appears to be just getting started. Hanna, Ike, and Josephine are still on their way. Storm-related interruptions to energy production in the Gulf of Mexico remains a possibility before the season ends. Crude oil and natural gas prices are therefore likely to remain highly volatile. Crude oil plunged more than six dollars yesterday and fell again today. It is now trading below $110, its lowest price since April. It is hard to believe that it was only five months ago that oil prices were this “low” before the run to nearly $150 got started.

The post-Labor Day trading session got off to a good start, but then equities reversed to the downside. Those who thought lower oil prices would boost the stock market were disappointed. As anticipated, volume picked up somewhat, yet it is still rather lackluster. Economic reports have not been as bad as expected, and exports have actually been a bright spot. However, the continuing onslaught of bad news from the financial sector tends to curtail any meaningful rally attempts.

The bond market is performing well. Investor nervousness about equities and diminishing inflation fears pushed the 10-Year Treasury yield down to 3.7%. Corporate and high-yield bonds are not enjoying the same investor enthusiasm. International debt is suffering from the currency translations of a strengthening U.S. dollar.


Consumer Discretionary has taken the top spot in our sector rankings, leaving many analysts bewildered. With difficult credit access, recession fears, and higher gasoline prices taking a larger portion of consumer spending, how can the Consumer Discretionary sector be performing well? Retailing is the industry within the Consumer Discretionary sector that is leading the charge. Remember those government stimulus checks? Many found their way into the coffers of discount retailers.

This sector experienced a -33% decline from its 2007 high, so it isn’t much of a stretch to think that worse economic conditions were already priced in. We are not yet prepared to issue an “all clear” on the Consumer Discretionary sector. SPDR Select Sector Consumer Discretionary (XLY) is at its 200-day moving average, where it met resistance in May and August. Additionally, skeptics believe the stimulus check boost was a flash-in-the-pan and assume that dismal back-to-school sales will justify their negative view.


The market still favors Small Caps over Large Caps. However, the Growth versus Value story is starting to change course. For most of the year, Growth has had the advantage over Value. Today, our rankings show that Value is performing better than Growth at all capitalization levels. The difference is most noticeable for Mid Caps. For now, the shift is not enough to warrant drastic action, but it is a trend that requires ongoing monitoring.


Commodity-oriented regions like Canada and Latin America had a brief rally toward the end of August and then collapsed the past two days, along with the retreat in oil prices. The U.S. dollar has been in a negative trend for most of the past six plus years. One exception was 2005, where it gained more than +12% against other currencies. Another exception is now, where it has gained more than +7% in the past two months. Like most trends, this one will not last forever. It is too early to proclaim that the six-year decline is over, as this could be just another one-year countertrend move like 2005.


The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.

“The secret to business is to know something that nobody else knows.”

Aristotle Onassis (b 1978) (1906-1975) Billionaire Shipping Magnate


As Deflation Takes Hold, Short Gold: DZZ

Brandon Clay

Pick of the Week: JNJ


If you read economic reports, the events they recorded have already happened. Whether its CPI or another monthly jobs report, you’re looking at a snapshot of the previous month’s activity in a collection of numbers. Our Picks of the Week are different. They’re designed to distill some of the latest market activity into a solid pick for your portfolio. We often find new information that allows you to profit with the ‘edge’: hence the name: Invest With An Edge.

Deflation: The Real Threat

For months the Fed and financial pundits have been talking up inflation. Until recently, they were right. Commodities like crude oil, gold, and agriculture took a trip to the moon. However, things have changed in recent weeks. Our research suggests an often-ignored force is now at work in the market. It’s ignored, because it’s rare. However, it can be devastating to our economy. What would cause such havoc to the financial markets? The dreaded culprit is deflation.

The financial markets work off banks lending to corporations and consumers. However, when banks stop lending, the system grinds to a halt. Consumers who can’t pay their mortgages default on their home loans. Banks then tighten their wallets to protect themselves from further losses. Companies that are dependent on credit from banks can’t expand and are forced into bankruptcy. Non-lending banks can’t make money, so they fold too.

Commodities Suffer During Deflationary Periods

If the process continues, then asset prices may be forced to fall. Commodities like oil, corn, and precious metals will decline. What once was a raging bull market suddenly becomes a roaring bear market for commodities. This appears to be what is happening in crude oil right now. NYMEX Light Crude Oil traded near $150/barrel in July. Today, oil closed at $109.35 – a substantial drop in less than 2 months.

We think deflation is a strong possibility in today’s market. Precious metals like gold and silver stand to lose in a deflationary environment with the U.S. dollar rising. In recent weeks, the greenback has risen against the rest of the world’s currencies. Since gold acts like a currency, we expect it to continue falling as the U.S. dollar strengthens. Like it or not, this is deflationary activity.

Short Gold Can Pay Big

One way to take advantage of Gold’s fall is with PowerShares Deutsche Bank Gold Double Short ETN (DZZ). If you were to buy DZZ, you would gain as gold loses. In addition, your returns (and losses) are magnified 2X as gold moves up and down. For instance, if the spot price of gold goes down $20 tomorrow, that would be a -2.5% loss for gold owners. However, with DZZ, that same loss would be a +5% gain if you owned DZZ at today’s close. See how that works?

Because of this unique situation, we offer a little more explanation on this pick. This is the first time we’ve recommended a short position. Short position investments are rare, because the market is upwardly biased. However, gold is different because it’s a commodity. Shorting is common in the commodities markets, hence less risky.

This is also the first time we’ve recommended a leveraged ETP (Exchange Traded Product). As you probably know, leveraged instruments are more volatile. Still, Leveraged ETPs are reset every day to prevent you from losing more than your investment. Such things can happen when using traditional methods of shorting and margin. Despite the increased risk of DZZ, we think it has the potential to pay out big. To profit from a deflationary trend, go with DZZ.


Keep in mind, the Pick of the Week is usually intended for aggressive investors. Don’t risk money you can’t afford to lose. You will need to decide when (and if) it is time to sell.

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