Stock Market Commentary
The stock market struggled for months against the downtrend line on market breadth. The struggle ended last week. My favorite technical indicator of breadth AT40 (T2108) broke out and closed the week at 61.9%. Now I start a countdown toward a test of the overbought threshold. However, several sectors dampened the week’s significance as they missed a breakout in market breadth. Stocks in the industrial and home builder sectors lagged as inflation fears seeped out of the market’s sentiment.
The Stock Market Indices
The S&P 500 (SPY) continued its steady creep higher and closed the week at a marginal all-time high. This chart represents the classic upward path of least resistance.
The NASDAQ (COMPQX) continues to sneak up on its double-top from February and April. I am patiently awaiting resolution of the coming challenge. The NASDAQ is a clear and strong buy on a break to an all-time high…especially if the market at that time decides that the economy has no inflation risks.
The iShares Trust Russell 2000 Index ETF (IWM) almost pulled off a breakout to an all-time high. Instead, IWM shied away at the very last moment. I finally got back on board with a calendar call spread with the short side expiring on Friday. The long side expires this coming Friday.
Stock Market Volatility
The volatility index (VIX) did not quite flash the all-clear sign. However, perhaps the latest plunge is good enough. I am looking for the VIX to make a decisive new low to signal the kind of complacency that can support an upward bias for the rest of the summer.
The Short-Term Trading Call Around Stocks that Missed A Breakout
- AT40 (T2108) = 61.9% of stocks are trading above their respective 40-day moving averages
- AT200 (T2107) = 80.1% of stocks are trading above their respective 200-day moving averages (TradingView’s calculation)
- Short-term Trading Call: neutral
AT40 (T2108), the percentage of stocks trading above their respective 40DMAs, closed the week at 61.9%. The narrative of a stock market with narrowing breadth came to an end. However, given important sectors missed the breakout, I believe odds are high that an eventual challenge of the overbought threshold with AT40 at 70% will fail. Accordingly, I remain quite comfortable staying neutral on the overall stock market.
The surprise drop in bond yields in the face of a hot inflation report presents a new wrinkle in the trading narrative. Reluctantly, I will be much less bullish on inflation plays like commodities, and I will get with the program on big cap tech and expensive growth stocks. The Spring’s growth tantrum offers a lot of fallen names to pick through. I will feature some of them in the coming days and weeks. For this post, I am more focused on what is suddenly not working: industrials, home builders, and related stocks.
Stock Chart Video Reviews
Stock Chart Reviews – Below the 50DMA
iShares 20+ Year Treasury Bond ETF (TLT)
The latest inflation data looked like it came in hot, but bond investors reacted by sending yields lower. This apparent contrarian move sent iShares 20+ Year Treasury Bond ETF (TLT) into a telling breakout above a 3-month trading range. Assuming bond yields are at least going no higher for the time-being, I am starting a rethink on my trading biases. For example, the industrial plays no longer seem as attractive as before. Moreover, the green light may be flashing bright and enthusiastically for expensive growth stocks and big cap tech.
Caterpillar (CAT)
Related to the drop in bond yields, heavy equipment manufacturer Caterpillar (CAT) dropped steeply first on Thursday and again on Friday. This 50DMA breakdown looks ominous and bearish for the stock. Accordingly, I changed my trading bias from bullish to bearish on CAT. I have one last tranche of CAT call options that will go out the door worthless.
Deere & Company (DE)
The decline in farm equipment manufacturer Deere & Company (DE) is not nearly as dramatic as the drop in CAT. Yet, the recent decline is just as telling. DE topped out in a churning trading range from March through May before a 50DMA breakdown confirmed the change in trading. DE sagged further last week.
Coupa Software (COUP)
A green light for expensive growth stocks could help procurement software company Coupa Software (COUP) bottom out. Even around a 52-week low, COUP still sports a hefty valuation at 28x sales. Last week, COUP lost 8.2% post-earnings. COUP ended the week with two strong days of buying (note the parallel with the two days of selling in industrial names) that nearly closed the post-earnings gap down. I am a buyer on a (confirmed) 50DMA breakout.
Sally Beauty Holdings (SBH)
An impressive 20.0% post-earnings pop for Sally Beauty Holdings (SBH) melted away the rest of May. Now SBH is struggling to prevent a confirmation of a 50DMA breakdown. I go short on such a confirmation. It is quite unusual to see such a strong reaction to earnings fade away so thoroughly, so this move has the look of a potential blow-off top from what was a near 4 1/2 year high.
Red Robin Gourmet Burgers (RRGB)
As a reopening play, Red Robin Gourmet Burgers (RRGB) topped out ahead of many other reopening trades. RRGB is down about 20% from its March high. May earnings failed to reignite excitement. I am not interested in going short RRGB because of my love for the turkey burgers at Red Robin Gourmet Burgers. Instead, I am looking for a close above the May high for a bullish signal. Of course, I would buy back in on a sell-off to 200DMA support.
Brinker International, Inc. (EAT)
Like RRGB, casual restauranteur Brinker International, Inc (EAT) topped out in March. The decline from there looks more definitive than RRGB. EAT fell as much as 26% before recovering from a 200DMA breakdown. With overhead resistance at the 50DMA holding firm, EAT is at risk for confirming bearish developments with a fresh 200DMA breakdown. For now, the 20DMA is holding as short-term support.
Vulcan Materials (VMC)
The materials play is starting to fall apart again. Vulcan Materials (VMC) first broke its 50DMA support on news of its acquisition of U.S. Concrete (USCR) on June 7th. Still, the 0.9% decline seemed minor. The rollback in yields was a bigger catalyst. VMC confirmed its 50DMA breakdown with a 3.1% decline. I am watching this space more closely than ever for clues on the market’s attitude about inflation risks.
LGI Homes (LGIH)
I further confirmed the end of the seasonal trade on home builders in my last Housing Market Review. Last week’s plunge in housing related plays further confirmed that call. LGI Homes (LGIH) led the way down with a 7.4% loss and 2-month low on Thursday. LGIH is a good stock to track given it is one of the high flyers in the sector. At 3.2 times book value, LGIH trades at a sky-high valuation for a home builder.
Hovnanian Enterprises, Inc. (HOV)
Hovnanian Enterprises, Inc. (HOV) sits on the speculative side of the home builder trade. I have a permanent “don’t touch” on HOV, but I do track its trading action.
I think of HOV as a home builder with chronically poor financials. According to TradingView, HOV has had negative book value since at least 2014. The price/book ratio plunged even further in April. HOV revenues peaked in 2016. It took the home buying frenzy of the pandemic to reignite some growth in revenues. Since the housing market bottomed in 2012, HOV has reported just 4 out of 8 years of positive net income. In other words, the stock performs like a trader’s plaything.
Short interest used to be extremely high. That measure of bearishness is now down to just 4.6% of float. Short squeezes cannot even explain Hovnanian Enterprises’s lofty levels. HOV lost 13.6% after reporting earnings on June 3rd. Sellers have been in charge since then with extended losses on heavy trading volume. Suddenly, HOV is down over 50% from its recent all-time high.
Meritage Homes (MTH)
I failed to fully benefit from my trade in Meritage Homes (MTH) after inadvertently taking profits ahead of the last earnings report. MTH became my one exception to the end of the seasonal trade by buying a small number of shares on the dip back to 20DMA support. I doubled the share count on Thursday’s plunge. That sell-off almost erased all of MTH’s post-earnings profit. This position in Meritage Homes is a small “hedge” against being wrong that the seasonal trade truly ended.
Redfin (RDFN)
Redfin (RDFN) looked “done” after its 15.7% post-earnings loss that broke 200DMA support. Even with the housing data suggesting sales could constrict, RDFN managed to bounce back from a deep trough in May. Last week’s breakout above converged 50 and 200DMAs erased all of RDFN’s post-earnings loss. These moves confound me, and I am not interested in buying. RDFN could be a short on a close below that last consolidation point at $57.
Stanley Black & Decker (SWK)
Toolmaker Stanley Black & Decker (SWK) shared in the pain of housing-related stocks. SWK has lost ground for 5 days straight and 8 of the last 9 on the way to a confirmed 50DMA breakdown.
Whirlpool Corporation (WHR)
Whirlpool Corporation (WHR) also helped confirm the weakening landscape of housing-related stocks. I took profits on my put option at the end of Thursday’s 3.2% drop. WHR confirmed a head and shoulders kind of top. I featured Whirlpool Corporation in my “Follow Through” piece last week.
Stock Chart Reviews – Above the 50DMA
U.S. Concrete (USCR)
I have been fortunate enough to see some high conviction investments turn into acquisition targets. I have been a fan of U.S. Concrete (USCR) for many years, but the construction play was the furthest from my radar as having buyout potential. Indeed, U.S. Concrete has been a perennial acquirer of smaller companies. I chose the wrong time to go empty-handed with Vulcan Materials swooping down on USCR!
Two ironies exist from missing this last surge for USCR. Firstly, I dutifully bought shares during May’s post-earnings plunge. I took profits when the stock faltered a bit in subsequent days. Secondly, USCR churned from there until I noticed a Bollinger Band (BB) squeeze form. I wanted to write a post on the implications of the squeeze and describe my next trading points (I only find time to write about a small fraction of my ideas and observations). The 29.3% pop was a perfect upside resolution of the squeeze!
The U.S. Concrete took on to build share was one of the reasons shorts seemed to hang around the company. USCR ended with 6.4% of its float sold short. I will now need to look closely at Vulcan Materials as a USCR “replacement.” USCR will always hold a special place for me as I got a special opportunities to interview former CEO Bill Sandbrook. Sandbrook helped me remain steadfastly bullish on U.S. Concrete.
Alphabet (GOOG)
Quietly, Alphabet (GOOG) has crept ever higher since May’s low. At that time, I made a bullish trading call that worked out. I have yet to return to GOOG. Technically, I should have bought the breakout on June 4th. Now, I can only wait for the next dip to produce a good risk/reward re-entry.
The Wendy’s Company (WEN)
Meme stock madness caught up with The Wendy’s Company (WEN) last week. WEN was part of my case for the “chicken sandwich trade” almost two years ago. So I was a little bemused to see the sudden surge in interest to the tune of a 25.9% one-day pop. WEN is a more unusual meme stock play given it has a large float and little short interest – in other words, the stock should be harder to push around well past valuation gravity. Not surprisingly, the excitement reversed quickly.
Despite the nuttiness of it all, I decided to jump in the fray. The chart below shows a stock biding its time in a tight 14-month trading range. This consolidation period gives last week’s breakout a higher probability of carrying follow-through at some point. I bought shares in two tranches and sold call options at the $30 strike against the position to take advantage of the sky high options premiums. The strike marked a point where I was fine taking profits. A volatility implosion helped me close out the calls near zero on Friday. The profits from the short calls helped cushion most of the blow from the pullback. Now I just wait for the market’s next moves…however long that will take.
Be careful out there!
Footnotes
“Above the 40” (AT40) uses the percentage of stocks trading above their respective 40-day moving averages (DMAs) to measure breadth in he stock market. Breadth indicates the distribution of participation in a rally or sell-off. As a result, AT40 can identify extremes in market sentiment that are likely to reverse. Above the 40 is my alternative name for “T2108” which was created by Worden. Learn more about T2108 on my T2108 Resource Page. AT200, or T2107, measures the percentage of stocks trading above their respective 200DMAs.
Active AT40 (T2108) periods: Day #151 over 20%, Day #135 above 30%, Day #22 over 40%, Day #13 over 50%, Day #2 over 60% (overperiod), Day #64 under 70% (underperiod)
Black line: AT40 (T2108) (% measured on the right)
Red line: Overbought threshold (70%); Blue line: Oversold threshold (20%). Chart always show the latest download date. Source: FreestockCharts
Source for charts unless otherwise noted: TradingView.com
Grammar checked by Grammar Coach from Thesaurus.com
Full disclosure: long UVXY calls, long SPY puts, long MTH, long CAT calls, long WEN, long DE put spread, long RDDFN put calendar spread
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*Charting notes: Stock prices are not adjusted for dividends. Candlestick charts use hollow bodies: open candles indicate a close higher than the open, filled candles indicate an open higher than the close.