JAKE MERL: Welcome to Trade Ideas. I'm Jake Merl, sitting down with Dave Keller, president of Sierra Alpha Research. Dave, great to have you back on the show.
DAVID KELLER: Good to be back, Jake. Good to see you.
JAKE MERL: So today we're going to be talking about AT&T. And right before the interview, off camera, you mentioned that there are four key components to this trade. What are they?
DAVID KELLER: Absolutely. So I think with AT&T, part of it is based on price, part of it is based on the yield-- the dividend component-- and then the other two are more macro factors, so a macro environment that's going to favor more defensive over offensive sectors and groups, and then the seasonality. So we're getting near to the seasonally weakest part of the year. So those four things together make it a compelling trade for me.
JAKE MERL: Great. So let's start out with the first one, just the price action. What are you seeing?
DAVID KELLER: So AT&T has certainly struggled by any measure. And on a price basis, it's down pretty significantly, about 18% in the last year. If you incorporate the dividend, it's probably more 13%, 14%, which is still pretty weak on a relative basis. So from a valuation perspective, it's certainly weaker or lower than it's been for a while. But for me, it starts to be compelling when you see a rotation from distribution up to accumulation.
I think that's what you're starting to see with AT&T is you have this clear pattern of lower lows and lower highs going into this year. You then have started to reverse. You've started to see a number of higher lows, starting to see AT&T break above some longer-term moving averages. And if you look at the last couple months, you could argue that it's a head and shoulders bottoming pattern, a low surrounded by two higher lows. We've broken above the neck line.
And if you measure that, that goes to the upper 30s, so potentially rounding out to a good long opportunity.
JAKE MERL: And so are there any other technicals out there that's confirming this thesis?
DAVID KELLER: So I think in general, I tend to be a trend follower, which is why this is more of an unusual idea for me. I tend to like to buy strength over weakness. But I like the fact that we've started to see the rotation. So if you look at any sort of measures of momentum, RSI, especially MACD, these are all starting to turn positive, so the long-term trend-following models starting to recognize that there's more of a bottom in place starting to chip away with some higher lows.
And that, combined with breaking above the moving averages, I think completes that thesis. So you get the early warning from things like RSI that something's nearing a bottom. Now you get the confirmation from more of the trend-following toolkit, and I would argue that's what we've seen already.
JAKE MERL: And so before, you actually mentioned the stock has a juicy dividend yield. What is it exactly?
DAVID KELLER: Yeah, so at current price levels, it's over 6 and 1/2%, which is pretty decent by any measure at any point. But you compare that to a savings account or anything like that, it's a legitimate source of yield at a time when fixed income is starting to struggle. So bond prices have gone vertical in terms of the yield on the 10-year getting down to 2.4%, so a yield of that level is incredibly compelling.
So if you have a price component that's favorable, but also incorporating that from a total return perspective, it can be a pretty good opportunity, I would say for the next six months or so.
JAKE MERL: And so how is the overall market affecting your thesis?
DAVID KELLER: Right, so on a price basis, I think it's attractive. I think when you compare it to more of the macro orientation, I think it's even more compelling. So we've seen recently-- this is in early, mid to late March, now into early April-- this emergence of leadership. It's technology-- it's been for a while, but now you've seen consumer discretionary semiconductor relative performance increasing.
Some of the things that are traditionally offense are actually blowing up pretty quickly, or rising to new highs. So in my mind, we're entering into April, which traditionally is a very strong month for stocks. You're sort of getting this feeling that there's one more gasp higher, which means a stock like AT&T could pull back to a really good opportunity to get into it. If we see a parallel movement, a little weaker on the defensive in the short-term, longer term I think it could be positive.
So from a macro perspective, what makes me think we have limited upside? Well, I think number one, we're approaching all-time highs. And again, maybe it's the fact that I started in the industry in 2000 so I'm predestined to focus on a return to highs as a negative thing. That served me very well in 2007, not as good in 2013. But for me, when I see that, I see things becoming overextended approaching a point at which people decided to take profits.
Sellers come into the market. I get a little concerned. And I feel comfortable raising cash or getting a little defensive just in case we have more of a downside than others might expect. So I think that's one concern is that we've approached the all-time highs, or we're getting near them again as we've broken above 2,800.
The second thing is just general breadth measures. So if you look at breadth on the S&P 500, still very constructive. So advanced decline line to new highs, pretty consistently there. So there's a lot of reasons to be positive on balance-- volume, other measures as well. But if you look at anything outside the S&P 500, much less attractive. So one of the charts I've been talking to clients a lot about is the small cap charts, micro caps, mid caps. None of those have confirmed the recent new highs in the S&P 500.
So while the S&P 500 in the last couple weeks has gone higher highs, higher lows, something like the IWM, the Russell 2000 ETF, lower highs and lower lows. And that divergence doesn't tend to feel good if you're thinking more offensive because that means the real juicy stuff, the small cap names that you'd want to be leadership, have sort of been struggling a little bit.
So in my mind, approaching new highs, weaker breadth, especially outside the S&P 500, tells me at least part of my portfolio being in something defensive with higher yield makes a lot of sense here.
JAKE MERL: And so what about seasonality? You mentioned that before.
DAVID KELLER: Sure, so as I mentioned, April is a seasonally very strong month. That's tended to be pretty good. So it's lining up very well with this renewed short-term offensive we've seen. And semiconductor relative strength is one of the better market tells that I've seen so, so when that's outperforming, we tend to be doing pretty well. And so we've just started to see that emerge.
But again, May through October tended to be much weaker on a relative basis going back decades through multiple cycles. So leading into the market approaching new highs at a seasonally strong part of the year, reaching those new highs at a traditionally weaker part of the year tells me this could be the opportunity to get more defensive. And I think you've already seen that in terms of flow.
So real estate, utilities, consumer staples-- some of those traditionally defensive areas have really started to see appreciation. Utilities and real estate ETFs both at all-time highs recently. So you're starting to see a move toward defensive, and I would say something like AT&T that has lagged a bit-- that combines with that seasonally weak thesis.
JAKE MERL: So given this market backdrop, how do you actually go about trading AT&T?
DAVID KELLER: Right, so I think at this point, it's a crucial moment as you see offense breaking to new highs, the market breaking to new highs, breaking above 2,825, 2,850. So it makes me nervous to be jumping into a really defensive position as that's happening because, as I mentioned, I'm a trend follower. So if the market's going up, I'm going to want to own stocks. And if it's going down, I'm not going to want to own it.
So having said that, I think AT&T's had that nice breakout from the cup and handle bottoming pattern. I could see us pulling back a little bit, so places we could pull back to, for me, 2,975 is the low from earlier in March. I think as long as we stay above that, it's a good point to get in anytime between here and there. If we would start breaking meaningfully below there, I think you'd have to revisit the thesis, especially if it takes a couple weeks and we go lower, that might be that maybe the seasonal trends are not going to emerge how we expected.
But I think at this point, it's a good time to be buying on weakness on AT&T. And then you see upside to 36, 37 would be a minimum measurement based on that cup and handle pattern. So pretty attractive overall.
JAKE MERL: And over what time horizon is this?
DAVID KELLER: Yeah, so in my mind, this lines up very well with the seasonal tendencies. So I think over the next couple weeks, it's a good entry point. And I would say it would be the next six months driving through the seasonally weakest part of the year being in a place like AT&T I think will fare pretty well on a relative basis.
JAKE MERL: So Dave, what's the biggest risk to this trade? Is it simply just the overall market action?
DAVID KELLER: Yeah, so I would say a big thing I'm looking at in terms of an alternative thesis to this trade is a macro environment. And especially here in early to mid April, if we continue into-- we're at the point where we're nearing the seasonally weakest part. If that doesn't emerge, and if you see things like the traditional offense-- semiconductors and consumer discretionary-- continue to go up, outperform on a relative basis into May when you'd expect some sort of correction, I think you'd have to revisit it a little bit.
But for me, the biggest tell would be something like the IWM, the small cap ETF. And again, a big part of this thesis is that divergence between the mega caps, the large caps, the S&P 500, S&P 100, and what you're seeing in mid caps and small caps. So if you would see the IWM start to reverse higher, break to new highs for 2019, I think that would mean you may want to revisit this defensive thesis and think more about following the trend even further.
For me, it's all about price. And if the price is at higher highs and higher lows, I'd want to follow that. So if we see a new high, and especially a new higher low for the IWM, I think that's going to be a really important chance to revisit more of the offensive side of market.
JAKE MERL: Well, Dave, that was great. Thanks so much for joining us.
DAVID KELLER: Anytime, Jake.
JAKE MERL: So Dave is bullish on AT&T. Specifically, he suggests buying ticker symbol T at current levels with a stop loss at 29.75 and a target between 36 and 37 over the next six months. That was Dave Keller, president of Sierra Alpha Research. And for Real Vision, I'm Jake Merl.