1. The Trend is Your Friend as Dispersion Rises
S&P 500 Adv-DCL (5 day MA)
-400
-300
-200
-100
0
100
200
300
400
9/4/2007
11/4/2007
1/4/2008
3/4/2008
5/4/2008
7/4/2008
9/4/2008
11/4/2008
1/4/2009
There’s been a lot of panic the last few days over worries that the President’s stimulus
package may not have enough of an impact to jump start the economy in the near-term.
On the one hand, the bulk of spending doesn’t really kick in until after 2009 and as I
mentioned in an earlier note (See Sector Trades – Coal vs. Industrials), “it will be some
time before proposals are made, bids are accepted, and plans are drawn up.” The other
side of the argument is that a weak 2009 was already priced in so any stimulus will
positively affect current eps expectations. My take is that 2009 and 2010 eps estimates
may be much higher or much lower than they are now so at the moment standard
valuation metrics PE’s, forward PE’s, P/S are meaningless. Relying on valuation to
determine the markets’ next big move is an exercise in futility. The charts above show us

2. The Trend is Your Friend as Dispersion Rises
that the S&P 500 bounced off its 75 day MA once again and appears to be headed lower
to re-test the November lows of 752. However, market breadth still seems to be rising
suggesting that there is some real buying even as the market sells off. It also suggests
that the selling is concentrated and that market dispersion has probably widened.
In the past three months, Financials and Industrials have fallen 34% and 14% respectively
while Tech and Health Care are each up over 3% during the same time period. Therefore
sector allocation and stock selection have become more important in recent months.

3. The Trend is Your Friend as Dispersion Rises
This chart shows distribution of individual stock returns vs. the Index for the S&P 500 for
two different time periods. The blue line represents the distribution of returns for the past
3 months. The red line is the distribution for the same time period two years ago
(11/20/06 – 02/20/07). As you can see, choosing the right (wrong) sectors and stocks is
a lot more rewarding (painful) in the most recent time period than it was two years ago.
Although I still believe that mean reversion trades will work (see previous notes), it’s
important to realize that while the market may seem range-bound, Tech and Healthcare
are trending higher and Financials and Industrials are making new lows. Admittedly,
Financials are in a world of their own at the moment but Industrials are selling off for
fundamental reasons mostly related to expectations being too high on the stimulus
package as I mentioned in a note a few weeks ago (See Coal vs. Industrials trade). That
trade appears to be working at the moment returning roughly 4% in the past two weeks.
I continue to favor the Energy mean reversion trade as well as the Materials vs.
Industrials trade. I also think the current trend should continue (trend is your friend) so
long Tech and short Industrials should continue to be profitable. I’ll have more Trend
trades in the coming weeks but at the moment I would be comfortable using ETF’s to get
long XLK/ short XLI

4. The Trend is Your Friend as Dispersion Rises
-Jeff McKeown