|Nef Value Research L.L.C.
Thought of the Week Issue 14 October 13, 2007
If you like, my ideas and you are a hedge fund or mutual fund portfolio manager, trader, or analyst then
contact me here to set up a meeting or a trial of my company’s services.
Before I get started with this week’s trading idea, I am going to take a moment to do a little house
cleaning. Guitar Center’s (Issue 7) takeover closed this week and investors received $63 a share. That
marked a 7.7% return for us…not huge, but it beat the S&P 500’s 5.6% return for the same time period.
The three other positions I mentioned in issue seven are still open and I will update you on their status
when they close. Personally, I have already closed my positions in AV and HUN though, as both stocks
came close enough to the deal close price for me to exit the position with a tidy profit. My motto is to
never hesitate to take a profit in one stock if you have found a better opportunity in another where the
money can be put to better use.
The second stock I want to update you on is Beacon Power (Issue 10). BCON is up 34.1% since I
recommended it and those of you who bought it to trade the near-term catalyst should take profits as the
catalyst has now passed. For those of you who bought it as an investment (the majority of you I hope),
the company has announced that it will build its first frequency regulation plant in New York. When
operational, the plant will help to hockey stick revenues and drive our investment returns higher. The
company will also initiate site development activities in New England, California and the PJM
Interconnection region. Once again, I think investors with long-term investment horizons should continue
to hold, while traders who entered the position to benefit from the near-term catalyst can take profits now
that the catalyst has past.
|S&P 500 (8/24)
S&P 500 (9/15)
Normally, I give a stock idea in this space, but today I would like to focus on the market in general. Currently many
of the TV pundits are euphoric about the recent 50 basis point Fed interest rate cut and its potential bullish
impact on the market. I am less sanguine. Indeed, I believe there are a number of data points that lean towards a
market correction near current levels. I outline these below.
• The first warnings sign that I see that the market may be headed for a fall is the fact that a major tenet of
the Dow Theory has not been fulfilled. Dow Theory states that when the Industrial Average hit a new high, for the
Buy signal to be valid the transportation average must soon follow for the signal of a new trend to be valid. As of
today, the Dow Transports are nowhere near setting a new high and has not seen the recovery that the Industrial
average has. Analysts have been cutting their earnings estimates for both the truckers and the rails and it is
likely the Transports will not be setting a new high anytime soon. Below is a chart showing the divergence of the
• A second tenet of Dow Theory can also be seen in the chart above. Dow believed that volume should
increase in the direction of the primary trend. In other words, during a bull market volumes should increase on
strong advances and decline on corrections. The above chart shows that the exact opposite is taking place. In
looking at the chart above, my call for a downturn could prove to be slightly early since we have not yet seen a
high volume day to signal the end of the current rally. Dow Theory holds that a high volume day after a long
advance may signal that a reaction high may form soon. The reaction lows and the resulting volume spikes are
clearly visible in chart above (January, May June & August), but so far we have not seen a volume spike to cap
the current rally.
• The S&P 500 chart seems to be exhibiting an ABC correction pattern. I have highlighted the potential
pattern below. While this pattern isn’t the easiest pattern to discern until after the fact, I believe that the non-
confirmation of Dow Theory, coupled with the uninspiring volume levels and the potential bearish crossover of the
MACD lines (shown in the chart below for the S&P and for the Dow on the preceding chart) hint that we may see
an ABC correction here.
• Earnings season starts in earnest this week and while I expect earnings to be in line for many of the
companies reporting, I am more concerned that guidance for the fourth quarter and for next year may be more
cautious than some of the bulls are anticipating. Housing is in a serious downtrend and this has impacted the
transportation stocks as they re hauling less building related loads. Moreover, the retailers have been struggling
as a group to show comp-store growth and this is also a signal that the economy could be weakening. Finally, the
financial stocks and the consumer discretionary stocks have been struggling with the credit crunch and I expect
this trend to continue in the coming months. All said, strong oil prices have been helping the energy stocks to
outperform and propping up the market. If the oil price begins to roll over, we could be in for a strong correction.
I hope you have enjoyed our free thought and I look forward to bring you more thoughts in the weeks ahead. If
you like, my ideas and you are a hedge fund or mutual fund portfolio manager, trader, or analyst then contact me
here to set up a meeting or a trial of my company’s services.
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