In The Week Ahead: The Breakout Stock To Watch As We Ring In The New Year

All major U.S. stock indices finished in positive territory last week except for the Nasdaq 100, which lost 0.6%. Technology stocks must resume their leadership role quickly, ideally with some help from small caps, to power this year’s broad market advance into 2015. If they cannot, the market could stumble into next year.

From a sector standpoint, last week’s modest advance was led by financials, health care and materials. Globally, the aggressive recovery by European equities is a good sign for U.S. stocks into the early to middle part of 2015.

#-ad_banner-#Seasonality, Congress Could Hurt Stocks This Week

Our first chart displays the weekly seasonal pattern for the fourth quarter in the S&P 500 based on data since 1957. Historically, the second week of December, which is this week, is the second seasonally weakest of the entire quarter. On average, it closed 0.21% lower while posting a negative close 56% of the time.

This chart is of particular interest to me this week because, despite the fact that it has received little coverage in the financial press, Congress has until midnight on Thursday to pass legislation to keep the government from shutting down. For perspective, last year’s government shutdown helped trigger a sharp 5.6% decline in the S&P 500 between Oct. 1 and Oct. 15.

Keep a Close Eye on Consumer Discretionary

Congressional jousting aside, the U.S. market appears to be on track to extend its 2014 gains into next year. One market sector to pay particular attention to is consumer discretionary, which my own ETF-based metric shows has had the biggest inflow of investor assets during the past month, and which has outperformed the S&P 500 by 3.4 percentage points since Nov. 10.

One consumer discretionary stock that caught my eye is Starbucks (NASDAQ: SBUX). After drifting sideways for a year, it resumed its larger August 2012 advance.

This breakout from a year of investor indecision targets a move to $93, which is 11.3% above Friday’s close. This target will remain valid as long as the upper boundary of the indecision area at $79.80 loosely contains prices on the downside as underlying support.

Rising Long-Term Interest Rates Likely in 2015

Initially in the Nov. 10 Market Outlook, and again in last week’s issue, I pointed out that the 2.4% level was a formidable overhead obstacle for the yield of the benchmark U.S. 10-year Treasury note. Yields subsequently rose to 2.39% on Nov. 6, before stalling and declining back to 2.18% by the end of November. They are now making another run at 2.4%.

The next chart is one of several metrics that supports a near-term rise above 2.4% and an eventual move back to 3%. It plots the CBOT 30-year Treasury bond future daily since 2009 and the corresponding 10-day moving average of the ratio of call option to put option volume in the contract.

This ratio currently indicates that we are at a multiyear extreme in optimism, i.e., futures traders think Treasury prices will continue to move higher as yields decline. The vertical highlights show that, as a contrary indicator, previous similar extremes in investor complacency/optimism have coincided with or closely led most of the important peaks in the T-bond contract.

Economically, the eventual move above 2.4% that this metric implies fits nicely with the October termination of quantitative easing and the surprisingly good November jobs data we saw last week, which may spur the Federal Reserve to raise interest rates sooner than previously expected.

The Smart Money Loves Copper

Beginning in the Oct. 6 Market Outlook, and as recently as the Nov. 24 issue, I have been discussing an emerging opportunity to buy base metals via the PowerShares DB Base Metals ETF (NYSE: DBB). Since then, DBB has drifted sideways to lower, but I still like base metals as an intermediate-term investment. One important reason why is because the smart money likes it too.

The next chart plots CME copper futures weekly since 2006, along with the weekly net position of commercial hedgers, according to the Commodity Futures Trading Commission’s (CFTC) Commitments of Traders (COT) data.

Commercials, who use the futures market to hedge their physical holdings in the commodity, are holding a record net long position in copper futures as of the latest data. This represents an historically aggressive bet by the smart money that copper futures are undervalued and likely to move significantly higher over the next one to two quarters. Similar but lesser net long extremes either coincided with or led the most important bottoms in copper prices during this period.

The positive correlation between copper prices and DBB, which includes copper futures as a core holding, suggests the ETF is likely to rise over the next quarter or two.

Putting It All Together

A 57-year pattern of seasonal weakness in the S&P 500 this week, combined with a potential government shutdown, warns of a near-term decline in equity prices. However, an expected rise in long-term U.S. interest rates and economically sensitive copper prices suggests that any short-term weakness that emerges this month is likely to lead to a better buying opportunity as the economy continues to strengthen into early next year.

Editor’s note: One of the best ways to benefit from a short-term market decline is by selling put options. Since February 2013, Amber Hestla has closed 78 straight winning trades using this strategy with an average annualized return of 43%. If you’re not familiar with her Income Trader service, you can view her track here and learn how you can start making the same trades immediately.

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This article originally appeared on The Sector (and Breakout Stock) to Watch as We Ring in the New Year