Watch For Plurality On A Micro Basis For Investing Clues

The markets leave clues. Reading these clues and understanding the verdict of the markets is one of the most important skills of a top investor.

What groups should an investor concentrate on for the long portion of his portfolio?  One of the best ways to determine this is to read the plurality of the markets' action. What groups are dominating the new high lists?  Are there any groups that are growing in number on the new high list that are showing stocks breaking out of four-week consolidations with consistent regularity each day or several times a week? These are the groups to focus on in your long portfolio. 

When a group broadens the number of issues that are making new highs the market is giving a strong indication that this trend is for real and is likely to continue. Particularly when the new highs are breakouts of four-plus week consolidations this adds technical credence and reliability to continuation of the trend. When the group also has many issues that are selling at a discount to their growth rate or expected growth rate (PE 70% or less of their earnings growth for the last two quarters and five-year growth rate unless the stock is a turnaround situation), this means there is plenty of room for appreciation without price getting in the way. Finally when the institutional sponsorship of a group is growing as it makes new highs and that sponsorship has not grown to dominance in the trading of stocks in that groups, it means that the elephants are starting to pile into these securities. It is also important to understand why a particular group is likely to continue to experience strong earnings growth in the future.

Currently one of the few groups that meets all of these criteria are regional banks. They are breaking out of sound bases, dominate the new high list, particularly our own Top RS/Top EPS new highs lists. Regional banks are often selling at a PE discount to their growth rates and are growing in institutional sponsorship without being dominated by institutions. Regional banks are benefiting from a very wide yield curve that is likely to remain in force as long as the Fed remains on hold from tightening policy. With the current deceleration in the rate of growth in the economy, the Fed is likely to remain on hold for many months.

The same scenario holds for finding the top groups to short. Look for groups that are making a large and growing percentage of the daily new lows lists.The best groups are showing stocks breaking down out of four-plus week corrections or consolidations many times each week. Are any of these groups still relatively overpriced when comparing their PEs to their growth and expected growth rates? Are institutions lightening their holdings in any of these groups consistently as they make new lows? And is there a reason why earnings are likely to remain weak or decelerating in this group.

Currently Telecoms, techs, media, semiconductors, and utilities seem to meet most or all these criteria and they are dominating the new low lists. These then are the groups that should be watched carefully for shorting opportunities. Telecoms are a good example of a group that has been dominating the new low lists for over a year. When the breadth of Telecoms making new lows begins to consistently lesson, and bases begin forming in most of these issues, that will be the time to begin to tighten up stops and look to a more consistently dominant new low group to rotate into. In the meantime valuations remain overdone in many telecoms and as long as they continue to dominate new low lists, investors should not look for any kind of bottoms.

One of the most important rules an investor should learn is to not fight the tape and to let the market be your guide, particularly when it is giving a strong and consistent message. A group which dominates the new high or new low list, has valuation that will allow it to continue moving in the direction of this trend for some time, is being accumulated or distributed by institutions, and is breaking out of valid technical patterns in abundance is giving strong clues that the trend being seen is likely to continue. It is not where the markets move, but how they move and what messages they are giving that investors should spend most of their time focusing on.

Whether we are near a market bottom or preparing for a new leg down is not as important to investors as knowing which groups are giving clear indications of further potential movement on the long or short side for a long/short investor. Paying close attention to reading the plurality of the market can yield much higher profits than focusing on where the main indexes are going. This is where we suggest most investors spend most of their limited time to leverage and improve investment gains.

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