Tom Yeung here with your Sunday Digest.
Last week, TradeSmith CEO Keith Kaplan hosted a presentation where he explained why we’re entering a “danger zone” for the stock market. In this free special broadcast, he was joined by legendary “quant” investor Louis Navellier to discuss look at what makes the late summer treacherous for investors… and to look at a few lesser-known stocks set for upcoming big gains, despite these seasonal doldrums.
They’re confident about these calls because Keith and his team at TradeSmith have developed a system they call Trade Cycles that tells you not just what to buy, but also when.
It’s a powerful quantitative tool I previously used to recommend some winners last January, like…
Now, Keith’s system is flagging a dangerous path ahead. August is a notoriously poor month for American equity markets, and many stocks associated with early summer rallies tend to deflate going into the fall.
However, there’s always a bull market somewhere. As we noted last week, back-to-school and other consumer cyclicals can perform marvelously in August and beyond.
So, if you haven’t had a chance to watch Keith and Louis’ presentation yet, I encourage you to do so soon before time runs out. Trade Cycles has become an essential tool to help regular investors against the best Wall Street algorithms, and we’ve used it to detect insights that no ordinary person could hope to see.
Click here to watch the free replay.
To give you a sense of the power of Trade Cycles’ insights, I’ve been permitted to give you two more picks from the system today.
The Off-Season Winner
Professional traders know that liquidity dries up during the summer months. In August, the slowest trading month, daily volumes on major U.S. exchanges average just 9.3 billion shares. That’s roughly 30% lower than the 13.2 billion seen in March.
The lack of liquidity means that volatility can suddenly spike… and cause havoc among unhedged positions.
That’s likely why Trade Cycles believes now is a perfect time to buy Cboe Global Markets Inc. (CBOE).
Cboe is the owner of the Chicago Board Options Exchange and the operator of BATS Global Markets. It also created the CBOE VIX Index, the market’s “fear gauge,” and has a monopoly over VIX equity contracts. Any trader seeking to hedge their positions using the VIX must transact with Cboe.
The Chicago-based firm is also the largest U.S. exchange for options – an essential tool for traders seeking to lower risk exposure (and for day traders looking to increase theirs). Every day, 17 million options contracts cross Cboe’s desks, generating as much as $15 billion in net options premiums.
That makes the volatile summer months an excellent period for Cboe and its risk-mitigating products. Over the past five years, Cboe has beaten earnings estimates in the third quarter by 4.7%, versus just 1.8% in the second quarter.
As the graph below shows, this creates a “slow burn” of rising share prices through the summer months, beginning on June 17 (the last days of Q2) and ending on September 10. A secondary boost typically happens in the fall in anticipation of fourth-quarter results.
That means it’s still not too late to add shares if you didn’t when I first recommended the company in January. Although the stock has risen 25% since then, our system believes there’s still plenty of upside left on this monopolistic firm.
A Shorter-Term Play
Americans love taking road trips. According to AAA, 62 million people took to the road over the Fourth of July weekend alone. By the time we reach Labor Day in September, roughly 200 million Americans will have taken at least one road trip.
All this driving has historically given a boost to gasoline refining companies. According to our Trade Cycles system, refiners such as Valero Energy Corp. (VLO) and Marathon Petroleum Corp. (MPC) see gains as high as 7% from these seasonal effects alone. In fact, this gasoline trade has become so popular that it’s generally over by July 31.
Below is a graph for Marathon Petroleum, which shows that we’re nearing the end of the seasonality cycle. The teal line shows MPC’s average movements over the past 15 years, which begin to drop after July 31.
The seasonality effect of MPC
So, what trend has longer legs (or wheels) from the summer driving season?
According to Trade Cycles, the answer is auto repair companies like O’Reilly Automotive Inc. (ORLY),which is my other recommendation this week. These firms provide repairs both before and after all the driving is done (not just during the road trip), and so they have a far longer seasonal bull cycle, as shown in the graph below.
ORLY is a particularly interesting firm because of its rapid growth. On July 23, the firm announced strong second-quarter earnings showing a 9.1% growth rate in the professional segment and a 3.5% rate in the do-it-yourself one. These figures are well ahead of competitors like Genuine Parts Co. (GPC) and Advance Auto Parts Inc. (AAP), which saw comparable sales rise just 0.4% and 0.1%, respectively.
Much of that has to do with O’Reilly’s 6,000-store footprint, which gives it significant advantages over online rivals. Its hub-and-spoke distribution channel means parts are often available within hours, and this national network has allowed ORLY to “crack” the e-commerce problem. Professional car service companies typically prioritize quick delivery times over low prices, because they can invoice end customers for the parts. O’Reilly’s distribution network is able to handle these requests.
The company also has a solid reputation for having knowledgeable staff, which has helped attract DIY customers. It’s much like Home Depot Inc. (HD) in the big box retailer’s earlier days.
Most importantly, O’Reilly has a history of solid capital management. The company has plowed excess cash into store expansion, improvements to its hub-and-spoke distribution channel, and stock buybacks. The company has also made strategic acquisitions at reasonable prices to expand its footprint.
Now, keep in mind this trade must be done as a short-term bet. Shares of O’Reilly trade at a fat premium to competitors’ (32X forward earnings versus GPC’s 17.5X), and traders are baking too much into ORLY’s long-term growth rates. ORLY has a justified value closer to $70.
Fortunately, Trade Cycles also gives a hint on when to sell. So be sure to hold ORLY through early September… and then exit your position before jumping back in for an early fourth-quarter rally.
The Algorithm That Never Sleeps
I’ll admit I was skeptical when Keith first told me about Trade Cycles. I had spent almost two decades studying markets from a classical “bottom-up” standpoint, and concepts like “intrinsic value” and “discounted cash flows” left no room for any market inefficiencies.
After all, if everyone knew that a company like Marathon Petroleum would surge in July during the summer driving season, then why not buy in June to front-run the market? Even smarter investors would then buy in May, and you eventually eliminate the seasonal effect altogether once you loop back to the prior July.
But it didn’t take long for Keith’s data to convince me otherwise.
That’s because the system shows you precisely how market cycles have worked in the past. You can plainly see that the brightest investors aren’t buying companies like Marathon Petroleum in August in anticipation of gains the following July.
So, why do seasonal effects exist when classical finance say they shouldn’t?
I’ve come to believe that algorithmic trading now dominates so much of market trading (over 75% by some estimates) that a lot of human wisdom gets lost in the mix. A momentum-seeking trading bot has no idea that companies like Cboe or O’Reilly see natural demand boosts in the late summer… and so they are constantly surprised when earnings go up.
That’s what makes Trade Cycles so powerful. The system doesn’t “care” if Americans go on driving vacations or if options exchanges like Cboe receive a surge of demand in the summer months. All it sees is what its fellow algorithms have done in the past, and then gives its best guess of what will happen in the future.
Right now, it’s seeing an incredible amount of momentum in certain stocks… and a wonderful opportunity to buy in while traders are on vacation.
So, check out Keith’s recent presentation. In it, you’ll see the Trade Cycles tool in action, plus discover the names of several stocks about to enter their most bullish stretch of the year.
Click here to watch the replay now while it’s still available.
Wall Street traders might be heading to the Hamptons, but their algorithms never take a break. With Trade Cycles in your corner, you don’t have to either.
Until next week,
Tom Yeung, CFA
Market Analyst, InvestorPlace
