Guest Author: Gary Scott

Welcome Gary Scott! – It’s Inverted

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Good morning, I’m very pleased to announce the addition of Gary Scott as a guest author here at the blog.  Beginning today, I’ll be posting selected editions of his daily newsletter in addition to some original content Gary may post from time to time.  Gary Scott is an economist and author of 36 international books and reports on investing.  For years, his World Reports newsletter was read by thousands of readers in 82 countries.  Gary began preaching the importance of global investing more than 30 years ago and wrote a monthly column under the bi-line “The Global Guru”, for “On Wall Street”, a large US circulation magazine for stockbrokers.

Ted Nicholas, one of America’s best selling self-publishers and foremost entrepreneurs, wrote “Gary Scott enjoys a worldwide reputation. He is an entrepreneur, author and investment advisor extraordinaire. While today it’s commonplace, Gary Scott was the first advisor 30+ years ago who recommended international diversification for the small investor. At first, many thought he was crazy. Of course, today the establishment advisors are on the bandwagon. Gary’s investment tips have probably helped more investors get rich than any advisor in the world!"

Gary’s “big picture” posts will prove to be a great compliment to the shorter term technical analysis of the markets and specific companies that I have provided here for the past couple years.

It’s Inverted by Gary Scott

In classical economics there is an economic cycle that normally swings from boom to bust and back again. Three different parts of the cycle create opportunity. 

One opportunity appears at the top of the cycle when the economy is at its peak. Business is booming. Everyone is getting rich. Share prices are high and racing upwards. There is rising inflation, short term interest rates are being pushed up, bond yields rise, unemployment falls and PE ratios expand. This is a good to time to sell shares and hold cash (CDs and short maturing bonds) that generally pay high interest.

Then the good times end. The economy peaks, inflation slows down, interest rates rise, there is depressed demand, rising unemployment and PE multiples contract. This offers the second opportunity as a good time to use that cash you are holding to invest in longer term bonds.

The economy slides towards recession. The yield curve inverts (short term rates are higher than long term rates) and finally reaches the bottom of the cycle. The economy has slowed way down. There is a rush for liquidity, , authorities relax monetary supply, there is high unemployment and a high level of uncertainty. Share prices have dropped and PE ratios are high. This, (when everything looks bleakest) is the third opportunity, a good time to buy shares.

Then the economy spurred by low cost labor and money picks up and works upwards into the next boom.

I share these facts because recently the yield curve on US Treasury bonds has inverted.

The yield curve measures the yield on interest-bearing instruments at various dates of maturity, from one day to 30 years. It compares the short-term rate with the long-term rate. For example right now, three-month US Treasury notes are yielding 4.35% and 6 month 4. 36% and one year notes 4.37%. This is as it should be. What is out pf place is that these rates are higher than the two-year to 8 year notes. At this stage there are only a few basis points and this could have little meaning.

However, if the trend becomes stronger it could be a warning that tougher economic times are ahead. This would suggest shifting emphasis from shares to cash.

This can also warn of a US dollar dip. Let’s keep our eye on the yield curve and enjoy good investing!

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If you’d like to see more about Gary or sign up for his daily newsletter, check out his personal site at www.garyascott.com

Currently, Gary and his wife Merri spend summers and conduct seminars at their 250
acre farm in the Blue Ridge Mountains (www.littlehorsecreek.com)  and
winters at their 800 acre hacienda in Ecuador (http://www.garyascott.com/archives/2003/01/27/index.html)

Mail Bag

What’s the Criteria for Adding Stocks to the Database?

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Question/Comment:

Thanks, Tate, for being so responsive. I also appreciate the feedback you give me to help continue the never-ending learning process. It is helpful to know that you have a watch list from which you take stocks for the database. Would you be willing to share the criteria for making the cut to your database? One of my ongoing questions is how to make this transition from my Scratch Pad to my Watch List. What I do now is look at the Breakout List and the 50-Day list and look for high scoring stocks from each list. These go into my Scratch Pad. After the market closes, I check out the stocks in my SP to see if they are close to a buy. These go into my Watch List for the next day with the appropriate alerts set.
 
My Response:

You’re very welcome.  The criteria I use is quite simple for the most part… im looking for sales and earnings growth first and foremost (usually above 20% quarter over quarter for both for at least 2 consecutive quarters).  A big part of my decision also goes into future estimates (for ’06 and ’07).  So if a stock has never been profitable but rapidly moving towards profitability with future estimates predicting big growth I’ll add it.  This is the power of using the human eyeball for adding stocks the database… this kind of stock would most likely be poorly rated by most computer generated databases.  I believe I catch many stocks that are off the radar.. but admittedly miss them at times too.  You will begin to see me catch more and more of these BEFORE the breakout as my tracking system improves and I add research help.  Also very important is ROE and profit margins – companies that are seeing accelerating growth in these areas will often be your big winners. 
 
Thats it for the most part.. sales/earnings growth, margins, ROE.. of course the overall ranking will take in other factors too, but if the company isn’t growing substantially it will never make it to the database. It really is a database of the worlds fastest growing companies.
 
You have the process down.. stick to researching the stocks in the first one to 2 pages of the breakout watch, hot stocks and 50 day screens.  Pick the best, put into a "hot list" or scratch pad as you call it and set alerts if appropriate.  Check your charts after the market each day and create another watch list for each morning.  So when you get up you might have 4 or 5 stocks that you will watch closely for entry.  Thats it really.  Gosh this game is easy right ?! : )
As a reminder, here is how I calculate the fundamental score of each stock (this is also listed in the Breakout Tracker help file)  Typically stocks scoring 20 or below would never be included in the database unless the technicals are outstanding:
FUNDAMENTAL: based on 30 points
  • 15 points (Earnings/Sales Growth): I look at consistency, history, amount of growth, acceleration and future growth estimates (future growth is very important something I noticed IBD wasn’t factoring in to their ranking system). I give it more weight in my system.
  • 10 points (Profit Margins/ROE): I look at relation to industry average and if it’s rising or declining.  (ie. if both margins & ROE are well above the industry average and have been rising the last couple years, the stock will recieve a score of 10)
  • 5 points (Management Ownership/Institutional Positions):  If management owns a large portion (say 20% or more) and institutions are initiating many new positions, the stock receives a score of 5.
Mail Bag

How About Shorter Time Frames for Sector & Industry Tracking?

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Question:

I’ve been perusing your site as a free member, & was wondering about the top industries tracking, as well as the sector strength tabulations.  Do you have a way of seeing those on a shorter time frame?  I notice that the sectors start at 15 day and on up, and the Top Industries tab I believe I read starts at 10 days and up.   It’s just my opinion, but the way industry group flow can turn on a dime these days and continue forcefully for 3 days plus—I would think that having an automatic way to see this on shorter time frames would be extremely helpful, as by the time you get past 5 days sometimes the strongest part of the move is already over. 

My Response:

Thanks for your question.  With all due respect I tend to disagree at least for the style of investing I use.  I don’t believe that performance over such a short time period defines a new trend.  Sure, you may miss some of the move, but I want to make sure a new trend is in place.  What I have found is that the top industries in 20 day performance is a short enough to avoid missing the move and long enough to define a new trend. 
  
A great resource for industry performance over many time frames is prophet.net which may provide many of the time frames you are looking for (you can see performance for 2 and 5 day).  Heres the link: http://www.prophet.net/explore/sectorrankings.jsp

State of the Stock Market

Springboard Off Support

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What a start to 2006.  It’s been about as good a start to 2006 as the start to 2005 was bad.. alleviating fears of another meltdown to start the new year and once again catching many off guard.  The breakout to multi year highs in the S&P and Nasdaq that occurred in November remains intact as price and volume movement in the first 4 trading days of ’06 indicate another leg up is in the works.  Clearly, the move on Friday with increasing volume indicated that the move after the releases of the Fed notes on Tuesday was much more than just a knee jerk reaction (which can often happen after Fed announcements).

All eyes will be on the Dow this week to see if it to too can join the party and maintain a breakout to multi year highs.  It will need to break above 10984 (high of the 2 year consolidation it reached in March of ’05) as well as psychological resistance of 11,000.  At this point that looks inevitable but some consolidation in the market should be expected at this point before moving higher. 

With a view of a multi year weekly chart of the Dow, you can see where a breakout needs to occur in the Dow.

   

The following charts illustrate the impressive moves off support following the release of the Fed notes on Tuesday.  There is no reason to believe at this point we can’t get another major move up (after a little consolidation)

Mail Bag

Do You Buy the Doom & Gloom for 2006? No!

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Question:

HI most of what read is the market going down , some of the reports siad a -10% ,,, can you comment?

My Response:

Which reports are you reading? Are these projections for 2006?  I won’t ever make predictions for an entire year because nobody really knows.  But based on price and volume movement in the first few trading days of January, I think the market is going to do very well for at least the next couple months.  I’ve posted a new market report at the blog if you’d like to have a look (http://investing.typepad.com).  While I won’t make a definitive projection for ’06, I would be shocked if the market is down 10% for the year.  I do think that we will have a better year this year than last, but we’ll see!
Stocks

True Religion (TRLG) – My Buy Process

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Yesterday I alerted premium members of SelfInvestors.com to a breakout in True Religion (TRLG), the rapidly growing high end jeans manufacturer.  The following is a follow up I report I sent to members last night to highlight the process that went into tracking the stock and making the purchase.  I wanted to share it on the blog as well because I think it illustrates well when it’s OK to purchase before the "formal" pivot point. 

"I wanted to write up a short report on the process that went into locating True Religion (TRLG) as a buy candidate and ultimately pulling the trigger on a trade.  As is the case with nearly all purchases in the Model Portfolio, TRLG has been listed atop the Breakout Watch screen for several days.  Believe it or not, I actually use this system I’ve been building over the past couple years! .. and it has been a key part of my research process, enabling me to pinpoint the best opportunities in the market each day very quickly.  I know that it can do the same for you too.  With the addition of the email alert system to SelfInvestors.com, you don’t even need to log in to track the best candidates in the Breakout Watch screen.  If you are a premium member, you may sign up to have this email delivered to your inbox.

As I do with all stocks that appear in the screens, I pulled up the chart of TRLG in order to get a better read on the health of the stock and to see if there may be a better buy point than what could be had by purchasing at the formal pivot point (.10 above the high of the handle formation).  In this case, the chart looked good with a surge in price and volume in the right side of the base followed by healthy consolidation.  The stock consolidated into a bullish triangle continuation pattern where prices converge to a point (forming a triangle) in conjuction with a dry up in trading volume.  It’s called a continuation pattern because typically the end of the convergence leads to a continuation in the direction of the previous movement (in this case up!!).  Of course these patterns aren’t ALWAYS successful, but more often than not they are.  In the chart of TRLG below you can see today’s "continuation" out of this bullish pattern, offering a better buy point then the formal pivot of 17.70.

 

Once I’ve located the stock in the SelfInvestors database, looked over the chart and determined where an entry point might be, I’ll set a real time alert around 1% below the potential buy price.  In this case I figured the stock would intially break out of this pattern around 16, so this is where I set my alert.  Once I’m alerted to the price, I know the stock may be on the verge of the move I’ve been waiting for, so I’ll begin to watch it closely in real time and have the order information inputed, so that all I have to do is click submit once the price is met.

I make buy and sell decisions by looking at a real time intraday 5 minute chart.  Below youi’ll see today’s intraday chart of TRLG and the buy point around 16.30.  Yes, bases work on the intraday charts too!  See the breakout from the cup base with handle today at around 2:30PM EST?  I never make a purchase if a stock has run up in the first half hour to hour of trading and will often wait for the stock to clear the high of the first hour of trading.  What the runup early this morning did was trigger my alert at 16, indicating this was one to watch closely throughout  the day.  Since I now had my high of the day I could set another alert just below that so that I’m not watching it all day (usually I have much better things to do!).  I set another alert at 16.20, which it triggered at 1:30PM EST.. and at that point it was time to watch closely for a breakout above the high of the day, which it finally did.  I had the order ready and pulled the trigger on the buy.

 

Hopefully I haven’t made this sound more complicated than it is!  Do yourself a favor and subscribe to a real time charting service with real time alerts (your broker or trading platform may include this), but a separate program may be best.  Esignal and TCNet are popular real time charting systems.  I’d also recommend investing in another monitor so you’re not having to minimize windows left and right.  You can just throw in another video card into your existing computer and pick up a very good CRT monitor for cheap these days.  The more computers and monitors, the better!"

If you are new to investing and have any questions at all about this process please don’t hesitate to contact me at support@selfinvestors.com. I’d be happy to answer any questions you may have.  Or you can leave a comment below if you’d like.

Stocks

Top Breakouts – Oil Leads the Way.. Again

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It had been a slow couple of weeks for breakout stocks as the market worked off recent gains, consolidating to major support areas.  That is until today’s big reversal following the release of the Fed minutes, indicating rate hikes are nearing an end while inflation remains in check. Today’s move was critical in that support in the major indices were dangerously close to being violated (in fact, the Nasdaq had breached support of the 50 day moving aveage early in the trading day).

With today’s big reversal came a surge in breakouts, primarily from the oil sector.  Oil had begun surging a few weeks back when I highlighted them in the last breakout stocks report, and today a climb in crude sparked another round of breakouts in the sector.  In all, 8 stocks in the oil sector broke out, led by highly rated PetroChina (PTR) and EnGlobal (ENG).

Here’s a screenshot of stocks that have broken out over the past 2 weeks, with a total rank of 50 or higher.  For a much larger view please have at this page.

PetroChina broke out today after consolidating for a month in the right side of a decent looking base.  Expect some resistance around 85 and 90 as it approaches all time highs.

ENGlobal continues its bullish action with today’s breakout move from the short handle.  The chart below shows a couple of high volume reversals (one from 10.96 and one from 9.20, which are negative, but those are most likely data glitches since they don’t show up in charts from other services).  I like that high volume gap up in the right side.

Be sure to take a look at the charts of other highly rated breakouts in the screenshot above..

State of the Stock Market

Expectations of the Masses

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Once again the market doesn’t deliver on expectations of the masses  .. not much of a surprise there.  Many market commentators had been wondering if we’d get the Christmas rally.  What was that we had in November?  The Christmas rally came it a bit early this year and another run up like that was possible but not probable.  The market was due for consolidation and that’s exactly what we’re seeing now.  No reason for concern as the market works off recent gains and consolidates quietly with holiday volume.  There seems to be some trepidation about January as the sell off of last January lingers in the minds of traders.  Perhaps the market will surpise the masses again and we’ll get a forceful rally and break to multi year highs once again.  We won’t get a true sense of direction until traders return from time off, but currently there is no reason to think that the run can’t continue after a bit more consolidation.  Support levels remain intact.  Here’s to a great 2006 – Happy New Year!

Mail Bag

Portfolio Position Sizing

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Question:

What percentage of the entire portfolio does each position represent?

My Response:

Typically, each pick will represent anywhere from 5 – 15% of the portfolio, depending on the state of the market, the stock being purchased, if its purchased at the pivot or off of support, etc..  Currently, a standard allocation is $15K.   Positions that I consider core holdings such as a Google or an Apple might get 20K while lower priced, higher volatility positions might get $7500.  I always make smaller purchases in a shaky market and for purchases off the 50 day moving average.  These positions typically are $10K.  Of course as the portfolio grows these sizes will increase.  On average I probably hold somewhere around 10 positions which offers a nice blend of growth and diversification.  In order to provide a Model Portfolio that is more realistic I’ll be working to implement the ability to use margin, include commission fees, etc. [update: this was included for 2006 when I used 10% of available margin] I hope to have this done some time this January.  Leveraging with margin is an important tool in a rising market and can really accelerate gains. Good question.. thanks.

ETF, IPO & Breakout Stocks Analysis, Tracking & Research