January 5th, 2011

Beware, Rotation Ahead

The market is clearly moving into the Mark-up from the Accumulation phase of its life cycle. Stocks that have been depressed or dormant for several years are starting to stir. If you’re one of those investors who has been hiding in fixed income or cash and have watch the market advancing inexorably are now probably looking to put some of that money to work in equities to take advantage of the next leg up.

The question you’re asking yourself is “What to buy?” Is it too late to buy stocks where the big money herd has already been, the stocks that have already appreciated 70%, 100% or even 200% over the past several months? Should you instead look in new pastures, stocks that are just now breaking out of well-formed secondary base patterns?

As always, the question you should be asking instead should be which stocks have the greatest potential for gain with the lowest amount of risk? Take, for example, these two stocks, RVBD (Riverbed Technologies) and JEC (Jacobs Engineering):

  • RVBD
  • JEC

RVBD is on everyone’s list of hot stocks and it’s appreciated 658% since the March 9, 2009 bottom. JEC has done literally “bupkas”; ever since its 70% decline in 2008 during the Financial Crisis Crash it’s been constructing (no pun intended) a symmetrical triangle base.

JEC isn’t the only stock still stuck in reversal patterns or secondary bases (extended 9-12 month consolidation patterns following significant moves higher). Over the past several weeks, I’ve been going through close to 2500 charts and found nearly 500 having similar characteristics. Alerting you to the Steels on December 12, I wrote:

“The market accounts for 50% of a stock’s move and industry group for another 30%. The steels are one of those groups where the stocks of industry members move pretty much in lockstep. With a strong market anticipated for 2011 and the group being one of those (along with financials mentioned earlier) that is beginning to move out of a multi-year long consolidation, it may be time to start nibbling at these stocks.”

This is what Wall Street means when they say “stock rotation”, when after running up a group of stocks (this time they included: industrial, rare and precious metals; technology, software and semiconductor; telecom; oil & gas, coal and other energy) the big money herd, now needs to find new, less risky, less inflated stocks to roll their billions into.

You won’t even notice as stock rotation takes place but one day you’ll wake up and notice that those names of yesterday will be mentioned more in terms of their declines than their increases and CEO’s in different industries will be the ones interviewed on TV.There are two keys to successful investing: 1) time the market (move to the sidelines when the market is in a free fall) and 2) set triggers to enable you to climb on early when the herd is rotating out of one set of groups into other.

It’s easy to rationalize and say that you’re going to go with a proven “winner” but that isn’t always the right move but one of my sell rules for reducing risk is to “Reduce exposure to an industry group if it falls out of favor.” It looks like that time may soon be approaching.

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  • oa92000

    steel got hit today, stay with it?

  • Joe

    I'm staying with steels. Most of the damage was with AKS, MEA,SCHN, USAP and IIIN; STLD was almost flat. Those stocks fell because of a GS analyst lowered their expectations … and you know what I think of analysts' expectations.