EB Daily Market Report - Tuesday, January 5, 2021
Executive Market Summary
- Futures were green overnight and our major indices opened higher
- Leadership today is coming from small and mid caps; the S&P 600 Small Cap Index ($SML) is higher by 2.14%, breaking further into all-time record high territory
- Energy (XLE, +5.78%) is having a very strong day, powered by a surge in crude oil ($WTIC, +4.70%) to near $50 per barrel
- Materials (XLB, +1.59%) is also strong as most of its industry groups is higher by more than 1%
- Industrials (XLI, +0.89%) and financials (XLF, +0.66%) are moving up as a result of a rising 10-year treasury yield ($TNX), which is up 5 basis points to 0.96%
- Technology (XLK, -0.10%) is a notable laggard, though consumer staples (XLP, -0.25%) has taken up residency on the bottom of the sector leaderboard
- Energy names like MRO, APA, and OXY - all up more than 10% - litter the S&P 500 leaderboard
Market Outlook
Below I mention that retail stocks are performing well. A favorite ratio of mine is following the relative strength of consumer discretionary stocks to consumer staples stocks (XLY:XLP). There's a VERY strong positive correlation between the direction of this ratio and the direction of the S&P 500. Currently, this ratio is trading at would be an all-time high close. It's difficult to be bearish when one of the most influential intermarket relationships is so bullish:
The blue-shaded area highlights the strong positive correlation (> 0.50), while the red-shaded area illustrates how often we see strong negative, or inverse, correlation. Clearly, it doesn't happen very often. A pullback in this ratio from time to time is fine, but if we a sharp decline, it would be one warning signal that we'd need to evaluation. Currently, this ratio is sending a great big "all systems go" signal.
Sector/Industry Focus
Retail (XRT) is bouncing off its rising 20 day EMA and its AD line has recently broken out to confirm this upside move:
Retail is a big part of consumer discretionary (XLY) and the consumer helps to drive U.S. equities higher. So long as the relative strength in the XRT is climbing as it is in the chart above, it's hard to be of a bearish mindset.
ChartLists/Strategies
Over the weekend, we issued our first EB Short Report, which featured a bit more information about stocks on our Short Squeeze ChartList and a trading strategy to consider. I actually traded the two stocks that I had mentioned on the report - Dillards, Inc. (DDS) and Michaels Companies, Inc. (MIK). The results have varied on these two for sure, but I'll walk you through my thinking on entering the trades, my strategy, and where I'd exit. First, let's start with DDS:
The trade didn't work and I got stopped out almost as soon as I moved into the trade. Here's a 10 minute, 5 day chart to illustrate my thought process. The reason I entered in the first place was the channel that had been started - rising lows each day recently with DDS in breakout mode. Check this out:
I think I made two mistakes with this one. First, and most important, volume on the recent breakout on the daily chart was light to moderate. A short squeeze should represent short sellers screaming for the exit. That was not in play here and I knew it when I bought it. My bad. Secondly, broadline retailers ($DJUSRB) were not in favor at all, on either an absolute or relative basis. That made it difficult for this trade to work as well. Lost roughly $140 on 200 shares. More tuition paid.
The second stock, however, was MIK and this one I still own and certainly appears to be much more promising. Let's look at the intraday chart:
Trading short squeeze candidates is a completely different strategy. I'm not sure I'd be looking to buy on pullbacks of multiple days, because those pullbacks may not stop. Short sellers don't cover on pullbacks, they cover when they get their profit target or when they get squeezed. What we're trying to do is benefit from the emotional pressure that will be applied to those on the short side as prices rise and break to new highs. The short squeeze begins and the exit of short sellers adds more buying pressure. And so the idea is to hang on for what could be a wild ride to the upside. One big risk of trading these stocks is news that could come out overnight with a resulting gap lower. Keep that in mind when you establish a position size. How much are you willing to risk?
I do not 'buy and hold" stocks that are heavily shorted. I try to avoid big losses.
Earnings Reports
Here are the key earnings reports for the next two days, featuring stocks with market caps of more than $10 billion. I also include a few select companies with market caps below $10 billion. Finally, any portfolio stocks that will be reporting results are highlighted in BOLD. If you decide to hold a stock into earnings, please understand the significant short-term risk that you are taking. Please be sure to check for earnings dates for any companies you own or are considering owning.
Tuesday, January 5:
None
Wednesday, January 6:
RPM, MSM, UNF, SMPL, GBX
Economic Reports
December ISM manufacturing: 60.7 (actual) vs. 56.5 (estimate)
Happy trading!
Tom