“Once you understand that news is not causal, you realize that even if you got it in advance, you could not forecast the stock market.”
– Robert Prechter
Shares remain in good shape overall. Intermediate trend, breadth, and volume are all solid. Within the list, the high-expectation segments like discretionary, and industrial outperform, a plus. That the defensive staples sector also outperforms recently indicates that large investors, if bullish, are somewhat divided as to economic growth slowing down in H1 of ’14. A mild negative.
One minus is the financial sector, which lags. In particular, the banks have underperformed for over three months. This is of interest to us, as interest-sensitive segments like the broad financials and narrow banks and brokers have historically served as a leading indicator of a primary top.
The averages sit very close to their recent highs, the S&P 500 off 0.8% from its high of last week and the Nasdaq Composite 1.1% below its high. It is hard to fault a market with this type of posture, good breadth, and good volume.
The speculative sentiment peaked weeks ago. This does not mean the market has to peak, but it does have consequences for medium-term speculation in speculative growth issues. The same great pattern that produces a nice gain in a market where participants are embracing risk will usually not work when a risk-off mindset pervades.
It is important, then, to carefully watch the leading titles each day to determine if sentiment may be improving at the margin. In particular, the Four Horsemen, iShares Nasdaq Biotech (IBB), Russell 2000 average of small-capitalization issues, and recent new issues are being watched for sentiment purposes.
The Four Horsemen decay at the margin, excepting Netflix (NFLX). Tesla Motors (TSLA) and LinkedIn (LNKD) stand in the 15%-17% range off their highs. This is normal for the gains they have recorded, though a speculator holding a concentrated account of three names and with liberal use of margin may feel differently if they held these issues while they were initially coming off.
Recent breakouts are of particular interest, as their follow-through, if any, says something about the ability of participants to take chances.
A few breakout failures from ledges and bases include Biogen (BIIB), ICON (ICLR), Infoblox (BLOX), Ocwen Financial (OCN), and Bonanza Creek Energy (BCEI).
Among the names, Insys Therapeutics (INSY) may serve as a candidate for sleeper of this cycle. We like the expected earnings growth in ’13 of $1.06 a share from a ’12 loss of 99 cents a share. In particular, we like the expected ’14 earnings growth rate of 58%. More interesting is the giant sequential revenue growth of the past two quarters. This trades $10.3MM in average dollar volume, so it is on the thin side. After plunging 15% four weeks ago on volume 380% above average, price has calmed down. Earnings are expected Nov. 12.
An aggressive player could consider a takeout of the 10/18 high of 44.52 as a potential entrance. This assumes comfort with holding a junior- or full-sized position through earnings.
Ligand Pharmaceuticals (LGND) was noted elsewhere as a breakout setup. The breakout did occur, and on volume 76% above normal. The stock subsequently followed through for a 15% gain. Price then sold off on heavy volume, leaving it just above the pivot. This is one to watch for sentiment purposes. With that said, it does not hold the same weight as the Four Horsemen or other liquid glamours.
Actavis (ACT) last week emerged from a series of ascending structures on volume 109% above normal. This may be the horse among the glamours. Estimates go from 56% in ’13 to 37% in ’14. This is a quality company, as earnings growth is rapid, revenue acceleration over the past three quarters is present, and earnings stability is very high at a standard deviation of just 7%. Companies with this level of earnings growth and this high of a level of stability are few and far between. The stock is extended and does not offer attractive entrance, but should be monitored for something opening up going forward.
Five Below (FIVE) has been discussed as a potential breakout candidate. Friday the breakout occurred, but price stalled at the pivot on volume 13% less than average. It is possible the stock comes out again over the next few days, and this possibility merits mention here. Earnings are expected late this month, so that uncertainty may be overhanging the stock.
(It is to be noted that the “normal” pattern of a market is for price to not make it past resistance or support on its first attempt, to sometimes make it on the second try, and to often make it on the third attempt. So FIVE’s behavior is not unusual.)
The timing of Amazon.com’s (AMZN) volume-backed gap-up of a week ago has the stock as a front-runner for leadership honors should the averages continue higher. There were a number of major accumulation days in September and October that add to the legitimacy of the stock’s leadership potential. We like the estimates and the estimate acceleration.
Given the overall tentativeness of the growth sector – which could certainly change in short order – we would not be entering the stock here, but would prefer to take it on a break to a new high, using the low of the gap day as the stop. One thing that is attractive is that AMZN has not had the move that other liquid glamours have had.
Acadia Healthcare (ACHC) is one we are watching for sentiment purposes, seeing as how it was a recent breakout. It is thin, at $9.6MM in average daily dollar volume, so it will not give us the same read as a larger, more institutional-quality name.
Priceline.com (PCLN) should be watched for sentiment reasons. It and AMZN come closest to being of the Four Horsemen’s ilk. There has been some distribution, but price holds with 5% of its high.
Harman International (HAR) is another we would be watching for sentiment reasons following its Thursday breakout. It is liquid, and so provides a better eye into institutional intent than some of the junior glamours.
Lumber Liquidators (LL) cleared a five-week pattern on heavy volume two weeks ago, but follow-through has been lax. Another to watch.
Evercore Partners (EVR) is a recent breakout that has lesser import to us, but is still on our sentiment list. The breakout went nowhere, similar to most recently.
Fleetcor Technologies (FLT) is another recent breakout that closed poorly on its breakout day despite heavy volume. This is of more importance due to its liquidity ($89MM in average daily dollar volume) and reputation as a big leader in ‘12/’13.
Qihoo 360 Technology (QIHU) is a very liquid leader and has special significance to us compared with most on this list. It certainly deserves to do nothing but digest the major gains from earlier this year, so more sideways action could be expected. But a breakdown on volume would represent something entirely different.
Of the above issues, only two fit the bill as pattern setups for a speculator to consider. The rest do not set up, but are listed here as they constitute some of the best vehicles with which to determine the market’s speculative sentiment. We watch these along with the Four Horsemen, Yelp (YELP), YY (YY), the biotechs, and the small-capitalization sector.
In summation, the averages stand tall. The leaders decay as large investors rotate out of high-expectation issues that have run up, and into low-expectation defensive and industrial names with reasonable valuations. Watching the averages is always important, but the speculative sentiment will be determined by the individual leaders, notably those above. We would not use this as a time to get aggressive and enter on pullbacks. We would stay in a generous cash position pending a shift in the speculative sentiment which would be evident by better follow-through in the names above.
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