Well, you know, Copper Mountain. The folks over there could not be too happy today. I’m sure these people work awfully hard, and they produced some great numbers today, earning 24 cents. The Street was looking for 23…yet the stock is getting crushed.… It is down about $24 or $25 to about $100.… The problem is the “whisper number.” The whisper number is 28 cents. That’s what I’m hearing.
ANDY SERWER, EDITOR-AT-LARGE, FORTUNE MAGAZINE
Appearing on CNN’s In The Money
Before every takeoff, a good pilot methodically goes through an extensive checklist. He does so to minimize the risk of an accident and thereby protect his aircraft and the passengers and cargo he is ferrying. The prudent macrowave investor likewise works his way through an extensive checklist before opening a new position. He does so to minimize his trading risk and thereby protect his trading capital. The macrowave investor’s checklist includes these three categories:
• Assessing the broad market trend
• Assessing individual sector trends
• Choosing potential trade targets
Ultimately, the macrowave investor is seeking to trade according to these two Golden Rules:
• Buy strong stocks in strong sectors in a stable or upward market trend
• Short weak stocks in weak sectors in a stable or downward market trend
Following these two rules will never guarantee a profit on any individual trade. But over time, the macrowave investor also knows that a strict adherence to these rules will put the odds of winning in his or her favor and thereby offer the path of least resistance to long-term success. Let’s work our way, then, through the macrowave pilot’s checklist with the help of two fictional traders, Charles Yeager and Angela Earhardt.
Charles is a macrowave investor living in Long Beach, California. For his day job, he’s an aerospace engineer at Hughes Space and Communications. Because Charles doesn’t have to be in his office until 8:30 a.m., he can trade every morning for at least an hour once the stock market opens at 6:30, West Coast time. And usually, Charles can trade the market close as well during his noon to 1:00 p.m. lunch hour. That’s plenty of time to make plenty of money, and Charles is as meticulous in his own stock research as he is with his operations research at the Hughes plant.
Angela, on the other hand, is an airline pilot based in Atlanta. When she’s not flying Boeing 767 jets to London, Madrid, or Tokyo, she actively trades. Like Charles, she is meticulous about her trading preparation. However, as you will see from observing these two distinctly different individuals, there are many different ways to assess market and sector trends and to choose your trading targets.
Indeed, it is ultimately you who will be the one to develop your own unique macrowave investing style. Nonetheless, watching how Charles and Angela go through their checklists can only help you in that process. So let’s start with how Charles and Angela each, on their own, go about assessing the broad market trend.
While Wall Street sweltered in unseasonably hot weather, technology shares buckled amid concerns over high valuations. An article in Barron’s questioning Cisco’s high price/earnings multiple, and its acquisition and accounting practices, triggered a sharp sell-off in tech stocks.
CNN
Charles Yeager’s trading motto is “Fool me once, shame on you. Fool me twice, shame on me.” After Charles got caught in the Nasdaq Crash of 2000, he decided he wouldn’t be fooled again by any phony euphoria. Indeed, if that crash taught Charles anything, it is how important macroeconomic events are in shaping the broad market trend. That’s why every Saturday morning, Charles starts his trading week by pulling his issue of Barron’s out of the mailbox and turning right to the Preview This Week section.
This section provides a detailed calendar of upcoming macroeconomic indicator announcements. These announcements begin each month with indicators like car sales, construction spending, and personal income and end each month with indicators like consumer confidence and the Federal budget.
As he scans the list of indicators, Charles likes to make mental notes of which reports are coming out on which days. He also notes which of the reports are more important, like retail sales, the Consumer Price Index, and the jobs report, and which are of lesser importance, like chain store sales and consumer credit. He then begins to scenario-build accordingly. For example, if the CPI number comes out unexpectedly hot, the Federal Reserve may well raise interest rates at its next meeting. This will drive the broad market trend down. Alternatively, if the jobs report shows an increase in the unemployment rate, this actually might be good for the trend if the market is sensing inflationary pressure. But Charles also knows that the market might react very negatively if it interprets the data as an early signal of recession.
After Charles finishes reviewing the macroeconomic calendar, he turns to the Barron’s columnists and articles. Basically, he is looking for two things. The first is the various views on where the market has been the past week and, more important, where it might be going. The second has more to do with his stock picking than with assessing the trend. Specifically, Charles wants to determine whether any particular stock or sector is receiving really favorable or unfavorable coverage. In fact, Charles once took a pretty big loss after a Barron’s story slammed his beloved Cisco. He doesn’t want that kind of thing to happen to him again—fool me twice, shame on me.
Once Charles finishes the columns and articles, his hard work really begins in earnest. That’s when he tosses on his reading glasses and starts combing the fine print. For example, one of his favorite sections is the report on Short Interest which shows whether the number of short sales are increasing or decreasing. Charles believes that a big drop in short sales will often point to an up trend.
In addition, Charles looks very carefully at several other sentiment indicators. His favorite is the Investment Advisors Bullish versus Bearish Readings. This contrarian indicator is compiled by Investors Intelligence, which polls a sample of investment advisors on the likely market trend. Charles knows that when the percentage of bulls gets too high, there won’t be enough additional buyers in the market to sustain a rally and a move to the downside is likely. By the same token, when the bearish reading really gets high, there is so much cash sitting on the sidelines that there is ready fuel for the market’s next strong advance.
As for Angela Earhardt, she’s no early Barron’s bird like Charles. Instead, when she’s not flying, she always sleeps in on Saturday. Partly, it’s from the perennial jet lag of a pilot. But mostly, its because most nights she’s up surfing the Internet until 2 or 3 in the morning looking for new stock targets and market trends.
As for how Angela follows the macroeconomic calendar, she much prefers the Internet. That’s why on Saturday afternoon she scans Web sites like Dismalscience.com. These sites not only list all of the upcoming events, they also provide in-depth analysis of each macroeconomic report. Angela uses this kind of information to develop her own market-trend scenarios.
Throughout the day, CNBC features in-depth news stories and interviews CEOs about market rumors and events that influence stock prices. This coverage will always affect the supply and demand in the stocks that are featured.
CHRISTOPHER FARRELL
While Charles and Angela live in different time zones and have very different sleep patterns, come Monday morning, when the trading week begins in earnest, they each will have two important things in common. Both will have their television sets tuned to the business news; both will be particularly attentive between 8:30 and 9:30 a.m. Eastern time.
This early morning window before the stock market opens is the macroeconomic data witching hour. It’s the time when many data reports are released by the government; and even though the stock market isn’t open, the bond market is. Both Charles and Angela know that the reaction of the bond market to the first day’s news is often a good indication of how the stock market is going to open.
For example, an unexpected spike in the CPI or GDP numbers might signal inflation. If bond prices fall sharply in response to that news, you know the bond market is signaling that the Federal Reserve is more likely to raise interest rates. That, in turn, will likely mean that the stock market will open down.
It’s not just the macroeconomic data that make the 8:30 to 9:30 time frame so important. During this time, the options market has also opened in Chicago. That means people are actively trading both Standard & Poor’s futures and Nasdaq futures; both Charles and Angela watch these futures closely in the little sidebar windows on their TV screens. If these futures are up significantly relative to the actual indexes and their so-called fair value, it means it could be a very good day for the market. And, of course, if the futures are way down, it may well be time to batten down the hatches or go short.
As for which TV shows they watch, Angela is partial to Bloomberg TV. At least part of the reason is that Bloomberg has excellent coverage of both European and Asian news—places where she flies all the time. This news helps Angela follow the more global components of her portfolio—stocks like Bookham Technology, Deutsche Telekom, and Ericsson. Even more important, Angela believes that a down market in Europe often presages a down market in the U.S.; so it’s a great market trend indicator.
Charles, on the other hand, believes that the European market is usually just reacting to yesterday’s U.S. news and therefore is a lousy predictor of the current day’s market opening. So he usually just tunes in to CNBC. It focuses more on the U.S. market. It also features a great cast of characters and some really great features, like Michelle Caruso-Cabrera’s sector watch, Maria Bartiromo’s machine gun analysis of the market opening, Tom Costello’s sprint down the Nasdaq lane, Joe Kernan’s sardonic movers and losers, and Charles’s all-time favorite, the fastest mouth in the bond market, Rick Santelli.
A stream of economic data since the end of May—ranging from housing, manufacturing to employment trends—had raised hopes that the need for much higher interest rates to stem the red-hot economic pace…was diminishing. But government securities slid after Friday’s stronger-than-expected June retail sales.… Market prices now point to a growing sense among market players that central bankers may tighten credit further at their meeting on Aug. 22.
INVESTOR’S BUSINESS DAILY
Interestingly, both Charles and Angela share one other thing in common besides a penchant for stock market TV. Both keep a running tab of the key economic indicators in a journal that they keep right next to their computers. Table 11-1 illustrates Angela’s approach. Here, she has listed in column one the major economic indicators in the order that the reports typically appear each month or quarter, with the quarterly reports in italics.
TABLE 11-1. Angela’s Macroeconomic Indicator Market Trend Checklist
As for column two, it rates the impact the report is likely to have on the markets, with a four-star report like the CPI far more likely to get a strong reaction than, say, a two-star personal income report. Note that the remaining columns use the letters U for up, D for down, and N for neutral to indicate in which direction Angela believes the latest indicator news will push the market trend.
For example, if the construction spending report for May shows a modest increase in spending and inflation is not a threat, that’s good news and Angela will pencil in a “U” under the assumption that this news will help move the markets up. In contrast, if the Purchasing Managers’ Index shows a decline into the recessionary range, Angela will pencil in a “D” for bad news and a downward market trend.
Now looking at Angela’s notations in the table, you can see that in some cases, like in column three, the news for a month—in this case May—will be quite mixed. Some reports are flashing positive signs for the market, some are flashing negative signs, and sometimes, the report is just plain neutral. This last is useful information in and of itself because it will often point to a sideways or congested market with no clear trend. Angela loves to scalp trade in this kind of market—it points to a trading-range market and what comes up to resistance levels in such a market invariably must fall back down to support levels. That’s a great environment in which to buy low and sell high.
But now look at column four. You can see that during this month, almost every indicator was bearish. That points to a clear downward trend. However, if you weren’t keeping a journal like Angela’s, you would likely miss this clear pattern and might get caught in the downdraft. Angela didn’t—she had a field day shorting all that month.
As for how Angela goes about filling in her table, she relies heavily on the Investor’s Business Daily and Wall Street Journal analyses of each report, as well as that of Dismalscience.com. She also carefully reads IBD’s Big Picture feature. This feature relates the movements of the market both to the latest macroeconomic news and to other market catalysts like earnings surprises, mergers, and new government legislation.
While watching the calendar of macroeconomic indicators to determine how the broad market trend fits into the category of fundamental analysis, both Charles and Angela also make very good use of several technical trend indicators. Charles’s favorite is the so-called “TICK,” which he includes in his online portfolio using the symbol $TICK. You might remember from an earlier discussion that the TICK is a summary statistic that subtracts the number of stocks that are advancing on the New York Stock Exchange from the number that are declining. Charles knows that a positive TICK during the trading day reinforces a bullish market trend. On the other hand, a negative TICK indicates that declines are leading advances and that the bears are in control.
Angela likes using the TICK, too, but never without also watching the TRIN and the S&P Futures. When the TICK stays steadily above zero, the TRIN ranges between 0.5 and 0.9, and the S&P Futures is trending upward, Angela can ring her scalp-trading cash register all day long. However, when the TICK and TRIN are running opposite to each other, Angela knows there is great danger. The bulls and bears are fighting it out, and if she gets in the middle of that fight, she can get badly mauled. That’s why she usually sits on the sidelines when the TICK and TRIN are at war with one another.
Let’s turn now to how Charles and Angela, each in their own way, go about assessing sector trends. The important questions are: Which sectors are strong and which are weak? Which are improving and which are deteriorating? And what is the pattern of sector rotation? For example, is money moving out of the telecom and computer sectors into defensive sectors like food and health care? Or is the flow of funds in the other direction?
As a print media kind of guy, Charles looks at several features in the Wall Street Journal to try to answer these questions. One is the Dow Jones U.S. Industry Groups table that lists the leading and lagging sectors from the previous day, as well as the strongest and weakest stocks in the groups. The other feature is the DJ Global Groups Biggest Movers. This table likewise lists the leading and lagging sectors and representative stocks, but does so both with more detail and from a global perspective. For a more detailed look at the subsectors, Charles will also review the Investor’s Business Daily Industry Prices feature. It ranks almost 200 sectors and subsectors based on their price performance over the past six months. It also highlights the previous day’s best and worst performers.
Angela, on the other hand, takes a totally Internet-based approach to her sector watching. For her technical analysis of the sectors, she uses Market Edge’s Industry Group Analysis. This tool can rank the sectors from strongest to weakest over various time periods using various technical criteria. It also indicates which sectors are improving and which are deteriorating. Significantly, this tool also allows Angela to easily identify both the strongest and weakest stocks in a sector. This helps when it comes time to implement the only-buy-strong-stocks and only-short-weak-stocks parts of her Golden Rules of trading. In addition, Angela always carefully monitors Smartmoney.com’s Sector Tracker, as well as its color-coded Map of the Market. The latter is a particularly useful tool to detect sector rotations throughout the trading day.
Besides assessing the market and sector trends, the other big task that Charles and Angela face each week is to find their trading targets of opportunity. Because they are both macrowave investors, they each understand that the best way to go about this is to rely on both fundamental and technical analysis. What is interesting about the two of them, however, is the order in which they do their stock screening.
Charles is a reformed value investor whose early heroes were Benjamin Graham and Warren Buffett. Because of his value-investing roots, Charles takes a bottom-up approach to his macrowave-investing stock research. With this approach, he begins with a stock’s fundamentals. Only after he has found fundamentally sound stocks will he then check that the technical aspects of the target are also favorable.
As for the stocks he actually researches, Charles is rather eclectic in his approach. Of course, he is an avid reader of such blue-chip magazines as Bloomberg Personal Finance, Business Week, the Economist, Family Money, Forbes, Fortune, Kiplinger’s, Money, Smart Money, and Worth. But Charles also subscribes to a variety of magazines like Active Trader, Individual Investor, Red Herring, and Stocks and Commodities. From his avid reading, he is constantly finding new stocks to investigate. Once Charles finds a stock, he only grudgingly logs on to the Internet. This is because even Charles must now admit that the Internet is far faster and more efficient than any print form of fundamental analysis. In fact, for this reason, Charles finally and unceremoniously dumped his subscription to Value Line after 15 loyal years.
Today, Charles uses Web sites like CNBC.com, Financialweb.com, Hoovers.com, Fool.com, and Wallstreetcity.com. Many of these sites have very sophisticated stock-screening tools that sort stocks based on everything from cash flow, dividend yield, and market capitalization to earnings per share, P-E ratios, and institutional holdings. These sites also offer historical price data, which Charles uses to calculate his stop losses. Being the meticulous engineer that he is, Charles will also check both Yahoo Finance and Earningswhisper.com for the earnings calendar for each of his potential trading targets. He not only wants to know the date of the next earnings announcements, he also wants to carefully compare the consensus number that represents the judgment of industry analysts to the typically much more accurate whisper number which is developed from a much broader sample of opinion. The last thing Charles wants to do is fall unwittingly into an earnings trap.
Once Charles completes his fundamental analysis, he moves on to the technical side of the stock picking equation. However, in this realm, even Charles would admit that his technical approach is rather primitive. In fact, the only thing he will ever do is to pull up a chart on Bigcharts.com and review a stock’s 50-day and 200-day moving averages. Charles’s rule of thumb is to never buy a stock that has fallen below either of these averages. He knows that when these moving averages are broken, mutual funds tend to start dumping large share blocks. This can send a stock down faster than a skydiver without a parachute.
In sharp contrast to Charles’s bottom-up stock screening, Angela prefers to go the top-down route. That’s why she always starts at the top with technical analysis. Sometimes, she does her own using the Cyberquant feature of her Cybercorp trading software. On a daily basis, she also checks in with Market Edge’s Money Runner for Today’s Buys, as well as with several stock picking subscription services like the Pristine Swing Trader, eGoose.com, and Changewave.com. As for Money Runner, this technical tool identifies both buy and sell targets based on a wide range of technical characteristics. These include not only moving averages but also much more complicated statistics like stochastic oscillators, relative strength indicators, Bollinger bands, and moving average convergence-divergence crossovers. In addition, Market Edge’s Second Opinion tool is an excellent source of support and resistance levels for stocks, and Angela uses these levels to help set her buy and sell stops.
Angela is, however, very cautious about basing her stock picks solely on technical analysis—or any subscription service for that matter. She not only knows from painful experience that the best buy or short recommendation is only as good as the sector and market trends that the position will be opened in, she also knows that the black box of technical analysis will often recommend buying a stock whose fundamentals are absolutely in the gutter or shorting a stock with stellar fundamentals. In such cases, she knows it is far too risky to take that technical advice.
That’s why Angela always checks a stock’s fundamentals after it has survived her technical screen. What she does to save time is to use a very simple but highly effective tool. This is the five-category rating system that Investor’s Business Daily uses to rank stocks daily. This system includes ratings for earnings per share, relative price strength, industry group relative strength, sales and profit margins, and the degree of accumulation or distribution of the stock. In using this IBD data, Angela’s decision rule is very simple. She won’t buy any stock in a position trade unless it has an earnings-per-share rating over 85 and a sales-plus-profit-margin rating of B or higher. And she won’t short a stock unless it has an EPS under 50 and sales-plus-profit margin of C or less.
As for falling into any earnings trap, Angela will never again let that happen. In the space of just two weeks several summers ago, she lost more than $25,000 on just three stocks—Nokia, VISX, and Worldcom. Each of them plummeted sharply on negative earnings news. In fact, the experience was so traumatic that Angela now schedules both her flying trips and vacations around earnings season so she won’t have the temptation to trade.
Moreover, because Angela got caught very early in her trading career holding a basket of drug stocks when the Clinton Administration proposed a health care reform bill that was a disaster for both Clinton and the pharmaceutical sector, Angela also knows to follow the political and legislative news very carefully. In fact, she is the only trader she knows who regularly reads the online edition of the Washington Post.
More broadly, both Angela and Charles always check the latest news on their potential targets. They are particularly interested in any regulatory or legislative developments affecting the stock, the stock’s sector, or, most subtly, the stock of a leader in the sector.
Charles usually does his News Screen at Redchip.com. This Web site even has a nifty portfolio tracker that e-mails Charles all the latest news stories about the stocks in his portfolio. Angela, on the other hand, prefers to use CBS’ marketwatch.com for her news check. And unlike Charles, who is offended by the coarse language often bouncing off the walls of the stock-picking chat rooms, Angela will always check the major Internet message boards. She knows there are many pearls of wisdom that can be gleaned from these boards despite the coarse language and the more than occasional swine who will spread false rumors about a stock in the hopes of causing a rise or drop in price.
As for checking the message boards, Angela always takes a short cut to CNET.com. At this site, she can type in the symbol for any stock and the search engine will pull in all of the messages from her four favorite boards: the Motley Fool, the Raging Bull, the Silicon Investor, and Yahoo Finance. As their final stock-picking screen, both Charles and Angela must determine whether a stock is a leader or laggard in its particular sector. Here again, the Investor’s Business Daily ratings are helpful to both of them. In addition, both Charles and Angela especially like to use the industry analysis feature of Bigcharts.com. It provides a list of the best- and worst-performing stocks over different time periods ranging from a week or a month to one or five years.
Both Charles and Angela know how much work it is to assess the market and sector trends and find excellent stock trading opportunities. But from personal experience, both of them also know how important it is to go through their macrowave investing checklist in preparation for the trading week. That’s why each, in their own way, is an excellent macrowave pilot.