When sectors start to decline the natural tendency is to want to look for “value” stocks. An example of this today is the internet sector which has fallen 18.1% based on the Dow Jones Internet Index. There are 40 stocks in the index and the usual suspects are members, Google, LinkedIn, Priceline, etc. The point being there are plenty of names we are familiar with and which have been great performing stocks looking back. A stock like LinkedIn, which is down 44.7% from the high, looks like a bargain. This is where we can out think ourselves and make bad decisions. Generally stocks have sold off or are “cheap” for a reason. Thus, we need to have a defined strategy for buying or investing in what some refer to as “fallen angles”. Without a strategy what has gone down can always go lower taking you with it.
The first course of action is to wait for the bottom to establish itself. As you can see on the chart above, that has not occurred as of now. Thus, looking for stocks in this sector is a crap shoot, or to put it another way, you would be better off to pick a number on the roulette wheel in Vegas. There is some support at the 235 level, and if it holds and builds a base, at that point would be the time to look for the opportunity. Determine what strategy you want to take if it does occur. Do you look for a trade (0-13 weeks) opportunities or do you want to look longer term? What catalyst would change the direction and outlook for the sector… write it down on the chart. Once you have established your approach then scan the 40 stocks and look for the best candidates , then build a watch list with each of them on it. When they, like the sector index, meet your criteria take the action design by you along with the risk management or worst case scenario going forward.
While you are waiting for this to unfold patiently, scan the other sectors looking for the current leadership and any opportunities they present as well. For example, energy broke through a key resistance level in early April and has move up 6.3% since the breakout. As you can see on the chart below it is currently testing the move between 785 and 800. If the eventual move from the consolidation is to the upside, that would be a continuation of the uptrend established off the February low, and one worth adding to or adding a new position in the sector. If you want to find the leading stock opportunities, simply scan the sector looking for similar consolidation near the current highs in a similar uptrend. Bird of a feather, tend to flock together.
As the current volatility plays out, along with the up and down syndrome the broad markets have adopted, look for the opportunities that give you lower risk entries versus chasing what we think will work. There are still plenty of opportunities in the various asset classes, the key is to not chase rabbits down endless holes. You can leave that to Alice in Wonderland and you can focus on what works in today’s markets.
For some charts of interest today look at Europe (IEV), EAFE (EFA), Dow Jones (DIA), Healthcare (XLV), Consumer Staples (XLP) and Real Estate (IYR). They are breaking from consolidation patterns to the upside and could present some opportunities with some nice upside follow through. The key is to be patient, let the trades develop and have a defined strategy to capture the move you expect to take place. Defining your time horizon for the move is equally important. Take it one day at a time and let the market determine the direction not you or the media.