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Now is the time to buy AT&T and Verizon, regardless of whether the stock market has peaked or continues to climb. Algorithmic signals show why.

SUMMARY:

  • Two scenarios that suggest now is the time to buy AT&T (NYSE:T) and Verizon (NYSE:VZ).
  • As money rotates out of top Mega Cap.Tech names (FAANGs & MSFT) it must find a home in other Mega Cap names and T / VZ fit the bill.
  • This topic has special relevance for investors seeking dividend income as 20+ year US Treasury bond (NYSEARCA:TLT) yields collapse.

Now is the time to invest in AT&T and Verizon. Our algorithmic signals (driven by statistics and probabilities – not emotion) suggest that the potential reward is very worth the risk we are going to be taking.

To be clear, this isn’t about calling a top in the FAANGs. (FB, AAPL, AMZN, NFLX,GOOGL) Instead, this is an exercise in acknowledging elevated risks and how to preserve capital while still capturing upside.

We see two possible equity market scenarios unfolding from here. Whichever direction things go we believe T and VZ offer a significant opportunity for both growth and dividend investors.

Scenario A – The Market Has Peaked; It’s Time to Book Profits and Rotate

Our algorithms are all about buying weakness and selling into strength. If we take a look at our algorithm designed specifically for the volatility of the NASDAQ100 (NASDAQ:QQQ) we’ll see a recent entry into the QQQ on April 20th. The QQQ at the time was trading around $132.75. Today we’re at $141.67.

April 20th represented the most recent and best reward vs. risk set up for QQQ Longs and buyers of the FAANGs and MSFT. Now, after significant strength, risk is elevated. We would be looking to raise stops on our position during this run based on highly calibrated algorithmic tools that suggest reward from these prices may not be worth the risk.

We’re not predicting that the markets have in fact peaked or are going to collapse. What we are saying is that risk is clearly on the rise at this point. Raising stops at this point keeps greed in check, an important practice when protecting a nest egg.

Here are some tremors that our investment algorithms recently picked up – and why they prompted us to raise our protection stops:

1 – There is what we consider an unhealthy narrowing of the markets.

We have a market that’s up this year. Everyone’s excited: The S&P is up about 7-8%. But when you drill down into the statistics (as Goldman Sachs has done recently in a fairly extensive report) what you’re going to find is that 10 stocks are responsible for 50% of the market performance this year in the S&P500.

Only 5 stocks are responsible for 40% of the returns of the 2017 stock market.

To make matters even more interesting: Only 5 stocks are responsible for 40% of the returns.

According to Goldman Sachs 10 stocks are responsible for 50% of the market performance this year in the S&P500.

So, unless you own Facebook, Apple, Amazon, Google and Microsoft your experience this year might be very different than what the averages are saying.

2 – Follow the capital flows.

A set of events shows us the warning signs, plus begins to illuminate the negative reward/risk developmentsā€¦.

  • On May 17th the NASDAQ100 dropped 2.5%. It was the fastest decline we’ve seen in a long time.
  • Then, of course, the NASDAQ100 immediately reversed and went higher.
  • However, on that day, we saw an enormous outflow of capital from the technology space (we use the ETF XLK as an example).
  • For the past 12 months this ended up being the biggest week of outflows for XLK.
  • So, while the markets are making new highs, major institutions – the institutional footprint – are starting to lighten up on the space.
  • You don’t have massive outflows like that without huge institutional exiting.

As an individual investor, you want to recognize those signs.

3 – Recognize the 5-sigma events.

The May 17th sell-off where we saw a 1.8% decline in the S&P (and a 2.5% decline in the NASDAQ100) was a 5-sigma event.

The May 17th sell-off where we saw a 1.8% decline in the S&P (and a 2.5% decline in the NASDAQ100) was a 5-sigma event.

In other words, a 5 standard-deviation of volatility above average volatility. That’s an event that occurs very infrequently. In fact, it’s happened only 18 times since 1928. But 3 times within the last 12 months.

(Today, June 9th, QQQ is trading 2.25% lower in another 5-sigma event. So, that’s 19 and 4 in the last 12 months.)

Since 1928 there have been 19 5-sigma drops.

As we get these higher prices we also get these tremors in the market where institutions are distributing. Then, after an incredibly speedy 3-day recovery, the market makes new highs in the following couple of weeks.

5-sigma drawdown leads to quick recovery in May 2017.

Even so, these 5-Sigma events are

  • the first signs that risk is elevated, and
  • perhaps rewards from this juncture in those stocks are diminished.

As these warning signs develop our algorithms begin highlighting new areas where the reward versus risk is optimal and we act accordingly.

What we need to do now is act like institutional investors:

Start rotating capital into assets that will be collecting the exodus from these 5 or 10 names.

We buy T and VZ because:

  1. Our algorithms suggest the correct reward vs. risk setup has arrived for T, VZ and the telecom index (ETF, IYZ).
  2. Mega Big Cap money rotates into other Mega Big Cap ideas. Understanding how institutional money is run helps us be in the right place at the right time.
  3. T is down 9% YTD; VZ is down 13% YTD. We look to buy weakness.
  4. Both stocks are resting right above big price consolidation bases that go all the way back to 2012.
  5. Both stocks sport a dividend yield of 5% (more on this covered below).

Scenario B – Markets continue their upward blow-off unabated

Under this scenario, no exodus occurs from the Mega Big Cap FAANGs and MSFT. Will this mean T and VZ trade lower? No, it simply means they will have to trade higher on their own merits and not because they represent safe places for the risk off trade.

Merit #1: Most important – 5% dividend yield

Dividend investors know that finding quality yield in a world of zero to negative interest rates is difficult at best and incredibly frustrating at worst. A simple review of T and VZ going back to 2012 will reveal that the optimal reward vs. risk time to invest in these stocks is during periods when the yields are 5%+. Moreover, one can begin looking for exits when the yields drop below 4.5%. (We’ll save our exit thoughts for another post.)

Merit #2: Our algorithm that directs our investment in long-dated U.S. Treasury bonds signals long rates are going lower.

Our algorithm told us to buy 20+ Year U.S. Treasuries (using the ETF, TLT) on May 12th which suggested a rise in price/decline in yield

Stocks paying dividends tend to go higher in price as long rates head lower. Especially Mega Big Cap stocks that can act as equity surrogates for debt investors (Hint: T, VZ).

Merit #3: Utility index (XLU) skyrocketing to new all-time highs recently.

XLU is the 1st respondent to the move lower in long-term US T-Bond rates. This leads the way for other Big Cap yield plays with solid balance sheets.

We know T and VZ are not just utilities. However, when XLU yields less than 3.5% and T and VZ are above 5% a discrepancy too large to ignore is building.

WHY WE BELIEVE IN AT&T AND VERIZON

What we believe we’ll see is this:

  • Money rotates out of the Apples and the Facebooks, etc.;
  • Finds its way into the AT&T and Verizon;
  • With interest rates on the long-bond coming down;
  • And breakouts across the board in utilities;
  • Showing the way for Big Cap dividend payers.

Add all of these factors together and you will see the ability to have capital appreciation while you’re collecting the dividend – the proverbial, “Having your cake and eating it too.”

CONCLUSION – AT&T and Verizon are offering ideal reward vs. risk opportunity

Everybody loves to have crystal balls and predict what will happen next. We don’t have that much hubris. We don’t know what’s going to happen next. All we can do is use algorithms to be on the right side of probabilities and statistics. This means we’re always looking to buying weakness and selling into strength maintaining the correct balance of reward vs. risk in our portfolios.

Can things go lower when you buy weakness? Or higher when you sell strength? Absolutely, and a sound stop-loss discipline is a must. However, if we do our job as investors – and constantly put our portfolios on the correct side of probabilities and statistics – we will prevail.

The major takeaway insight from the above outlined events and the algorithmic response focuses on one actionable detail:

Even if the market continues to go higher, the time to be buying AT&T and Verizon is when they are down 10+% collectively on the year, they yield 5%+ and long rates are headed lower.

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