INSIGHTS

On June 08, 2011

Selective stock picking essential in June

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“June is apt to dish out stock picking opportunities and rotational flavor-of-the-week sector movements.”

May did not serve up any technical revelations. The month presented a mostly non-descript character with accelerated action but virtually no fresh trends that bore evidence of a shift in market leadership. The stock market’s range-bound vacillations did not meaningfully expand the boundaries on either side. The monthly weakness could easily be interpreted as a reaction to a seemingly endless stream of disturbing economic news and geopolitical events, but the technical profile seems to indicate more apathy than swelling fear. Still, by month’s end many leadership stocks were showing signs of momentum fatigue. May did not position June to be a remarkable month. Against a likely backdrop of more of the same, June is apt to dish out stock picking opportunities and rotational flavor-of-the-week sector movements.

In the past 12 months, the Dow Jones Industrial Average (DJIA) has sustained no fewer than six abrupt and steep declines that have routinely breached widely acknowledged trendlines only to recover quickly and resume its basic ascending pattern. Despite these numerous event-incited retreats, the stock market has not lost its upbeat and consistent rhythm. For those simply regarding its trendlines, the stock market’s message may be somewhat obscure or lost altogether. Throughout much of this cycle the stock market has had regular excursions below popular trendlines underscoring the risks of addressing the market from a purely short-range trading perspective. With the obvious exception of the 2007-2008 downturn, this market cycle has validated a buy and hold strategy. Selling stocks or dismissing buying opportunities simply because of general market volatility may have, at times, cancelled the opportunities to participate in significant return potentials offered among broad and diverse categories from consumer discretionary to industrials and commodities.

June began with the sour note of a weak unemployment report for May. While I do not think that this is a harbinger of sustained market decline, it is most likely that further consolidation may ensue within recently established trading range margins. Market sentiment remains mixed, valuation are not lofty by historical standards, interest rates are low and likely to stay that way in the wake of the latest jobless figures and earnings are qualitatively improving among many industries. At the same time, volume trends are listless suggesting that insufficient numbers of investors have been lured from the sidelines. While the slowing momentum is causing price drift to intermediate support levels in many cases, this is occurring in an orderly and gradual manner. Many leadership stocks are braking their uptrend momentum, but I believe this should be considered within the context of the big gains that have been realized in these stocks and their representative sectors during the last year or more. Most importantly, there does not seem to be a significant change in the market’s leadership roster. Several sectors such as agriculture, cloud technology, heath care, industrials, rails and specialty chemicals have not lost their technical foothold and could be at the fore of a possible summer rally.

Bulls may take some comfort in the relative performance of the Dow Jones Transportation Average (DJTA) versus the Dow Jones Industrials. The Transports have bested the Industrials by more than 200 basis points over the last 12 months – a hopeful sign that economic activity is picking up based on more freight traffic and better airline profitability. Among the transports, the rails are a standout sub-category. The railroad group meets my criteria as a leadership sector for the long haul based on the uniformly bullish technical profiles of representative stocks. Most of the individual rail stocks are trading within 5% of their 52-week highs, most of which were reached during May. Despite May’s weak performance, the railroads showed good relative action and I believe this warrants a top spot on investors’ shopping lists amid any further short-term correction. If the rail stocks were to retreat further from their current closings (June 3rd) to their respective 200-day moving average levels, the median decline would be about 10%, but this compares with my forecast for upside potentials greater than 18% over the next 12 months. In my opinion, this sector deserves inclusion in a strategically diversified equity growth portfolio.

Can the market withstand the seemingly unrelenting downward pressure of the financials? Probably not for much longer, but this beleaguered sector is highly oversold and may be poised for a rebound. I still recommend underweighting this group until the technicals offer something more than oversold bounce opportunities. However, even moderate firming of this group may contribute to a summer rally I mentioned previously. With the Dow Jones Industrial Average well below its recent peak levels above 12,800, equities are becoming considerably oversold. Although the 200-day moving average resides around 11,600, it is quite possible the DJIA will find psychological purchase at 12,000.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the disclosures webpage for additional risk information. For additional commentary or financial resources, please visit www.aamlive.com/blog. For additional commentary or financial resources, please visit www.aamlive.com.