Monday, January 5, 2009

Is the consumer really dead?

2008 was certainly no joy ride for investors but 2009 could well turn out to be a walk in the park if the turnaround in the Consumer Discretionary sector is any indication. One ETF dedicated to this sector is the Powershares PEJ, a medium sized blended fund (it contains a mixture of growth and value stocks) designed to track the Dynamic Leisure & Entertainment Intellidex, an index composed of thirty stocks culled from the restaurant, gaming, leisure, and media industries. The three and a half year old fund hit an all-time low of $6.15 on November 21st, off 68% from its July 2007 high near $19.50.

A bullish chart
The November low formed the head in an inverse head-and-shoulders pattern as shown in the stock's daily chart below. The left shoulder formed during October, the head in November, and the right shoulder in December. The neckline was broken last Friday indicating that the stock is poised for a strong upwards move. Theoretically, one wants to see the neckline broken on heavy volume but last Friday's lackluster action can be forgiven since it was a holiday-shortened trading day with many people on vacation. Today's action, however, more than made up for Friday's shortfall with the PEJ trading over twenty times normal volume! (Average daily volume is only around 9000 shares.)

Profit expectations
Once a stock convincingly breaks its right neckline, theory tells us that we can expect it to move to a value given by the neckline +/- (neckline – top of head). (+ for inverse formations; - for normal head-and-shoulders formations.) For PEJ, the neckline is at $9.40 and the top (or bottom, depending on your point of view) of the head is at $6.20 which means we should expect to see the stock rise to the $12.60 level. This represents a 28% increase over today's closing value of $9.85. Not a bad return! [Note: PEJ is not optionable, alas.]

Top 10 PEJ holdings
The table below shows the most recent top ten holdings for the PEJ. All together these stocks comprise almost 47% of the fund. From looking at the component charts, it's no wonder the fund has broken out. All of these stocks have been badly beaten down with the sole exception of MacDonald's which is nearing an all-time high.

If you're a DIYer and would rather concoct your own basket of stocks from this list, you may wish to start with Yum, Liberty Media, Brinker, and Ticketmaster which have all charged out of their recent black holes and broken out of their bases. Close on their heels are Marriot, McDonald's, Carnival, and Starbuck's. Pulling up the rear is International Gaming which needs to break $15 before I'd be a buyer. Disney is the only stock that seems to lack clear direction. It's been bouncing around the the low to mid-20s for several months and I'd prefer to see it break $26 (or better yet, $28) before stepping in. Based on previous price highs, this stock has less room to run translating into a lower potential return compared with the others.

[Note: The "Comment" column in the table represents the PEJ portfolio percentage.]

I'm not sure what a breakout in consumer discretionary means for the overall economy, but it suggests that fear in the financial markets could be unwinding and those stocks that have been brutally and perhaps unfairly discounted are being re-evaluated. Or, maybe it's just that folks are getting tired of all this fiscal belt-tightening and are looking to kick up their heels. I don't know, but whatever the reason, the charts are telling me that now is a good time to take a gamble on this sector.

1. Liberty Media has three ticker symbols--LINTA, LMDIA, and LCAPA. I don't know the difference between them so I chose the one with the highest average daily volume.
2. PEJ currently pays an annual distribution (dividend) of just over 1%.

No comments: