Traders should become familiar with a widely accepted business-cycle flow chart as shown below in Figure 1. This was published in my third book (page 37) Forex Conquered, High Probability Systems and Strategies for Active Traders, John Wiley 2007. This can help traders by identifying if market environment conditions are in a late or early stage of economic expansion or recession. Then armed with this assessment we can better focus on what to expect for a market move.
Since most markets especially Stocks, Commodities, and Foreign Currencies demonstrate seasonal price patterns, meaning they tend to make highs or lows near the same time period year after year, we can determine if a move might be either be muted or magnified depending on the state of the economy.
For example when the economy is in a recessionary environment the effects may cause a decline in demand, then when we are in a period of a seasonal price decline of a specific commodity then that is when I would expect a more significant decline that are from a historic sense, or from an over valued market condition. On the other hand in a recessionary environment when a market is in a period of a seasonal low we might expect a muted price gain as decreased demand weighs on the market, therefore one can adjust their trading strategy accordingly.
Figure 1
As we come close to the mid-point of the year, it is most likely a good time to reflect upon where the economy is, especially after the first quarter GDP figures were released. The U.S. economy expanded at a 3.2 percent annual rate in the first quarter. In the same period The Federal Reserve's preferred measure of inflation climbed at the slowest pace on record. More positive economic news came on Friday with the Institute for Supply Management, Chicago's Purchasers Management Index rising to 63.8 from 58.8 in March. That was the highest level since April 2005; figures greater than 50 signal expansion.
According to the business flow chart, if the economy is to enter a period of early expansion then we would like to see confirmation from healthy gains in these three sectors, Financials, Transportation and Technology. A look at year to date figures absolutely confirms the economy is in a recovery mode. The financial sector is up 9%, the transportation sector is up 12.5% and the Technology sector is up over 10%.
But in order for us to make a high probability low risk trade it is important to do a bit more homework. For example we need to look at the subsectors within these groups. In the Transportation sector for example we have railroads, Air Freight & logistics, Marine, Airlines and Trucking. Indecently, Railroads have out performed this group year to date. Trucking is the lagging performer. What can we do with this analysis? For starters we can look at individual stocks within the subsectors for trading opportunities based on a relative strength comparison and search for trade set-ups for underperforming stocks that might give us a better risk to reward profile.
Let's examine the Marine sector as we are now dealing with one of the worst oil disasters in America. Currently crude oil is escaping from the well at a rate of about 5,000 barrels a day, five times faster than previously estimated, according to the U.S. Coast Guard. At that rate, the volume of the leak would exceed Alaska's 1989 Exxon Valdez accident by the third week of June. British Petroleum (BP) and Transocean (RIG), who are responsible for the accident, have seen their stock values plummet in the last few trading sessions. However, there are opportunities. As we say in this business "for one who loses there is one who gains."
Taking a look at the Transportation Marine Subsector, several stocks have seen pretty good moves lately, Genco Shipping (GNK) Global Ship Lease (GSL) and Excel Maritime (EXM). On April 7, based on Seasonal studies combined with understanding the business flow chart above, I wrote a blog titled "Have the Ships Sailed". In that article, I wrote... Hey folks, while most are concerned about the economy, and the impending market correction, remember corrections can come in one of two ways down or sideways (choppy conditions). In the meantime I still find opportunities in the (SPY) credit call spreads, Furthermore, don't lose sight of opportunities in seasonal sector plays. Specifically sub-sector analysis shows a bullish play in Transportation, but specifically Marine stocks. Check out (EXM) and (DRYS) for continued upside moves through July! Look for a pullback next day or so on both these for a buying opportunity.
On April 8 (EXM) pulled back to a low of 6.09 and has traded as high as 7.50 as of April 28. Currently it is back to 7.09. As for DRYS that stock moved in the same time period from a low of 6.10 to a high of 6.82. It is now at 5.85. This shows two things, A.) We need to use stops and B.) One needs to diversify.
If you are to explore opportunities in the Marine transportation sector, with this natural disaster we would want to find out if shipping lanes will be closed and if so which companies will be affected. Who will lose in lost revenue and who will gain? Companies that specialize in clean up and companies that will service transportation of cleanup materials will benefit, in addition to chemical companies, who will most likely benefit from this disaster. One more stock that is braking out is Frontline (FRO). In this environment I would say the best strategy is to stick with the winners, the leaders in the sectors and the sectors that demonstrate strength headed into the summer.
With this in mind let me share with you that the Transportation sector tends to remain strong headed into the end of the June time period and then tends to decline with overall market weakness through October.
As for the overall market remember that phrase "sell in May and go away"? Well no one ever said it was the first of May. Also, take into account that corrections come in several forms, hard hitting reversals and choppy consolidation patterns. I still stand by my statement from early April that we can look for income producing strategies such as credit call spreads on rallies in the broad based markets until July. After all, the economy is in a recovery mode. But just to give you insights into my game plan, when we hit mid July, it is at that point, we tend to have a "Summer Rally" as second quarter earnings season gets under way. That is when I would look to get aggressively short as we head into the month of October as we focus on uncertainty especially with the November elections.
I am sure I will have the opportunity to provide more insights between now and then, besides many of you have the DVD trading course and will be looking for the Seasonal set-ups that we covered in that course. I sincerely hope it has helped in your trading approach this year.
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