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Breakdown

Why the market's decaying internals might portend trouble ahead. Also, Legacy Oil + Gas makes a tuck-in acquisition

When he was younger, Max Fawcett wanted to make a mint in the markets. Now as the managing editor of Alberta Venture he gets to write about them. Close enough, right? He can be reached at mfawcett@albertaventure.com

May 9, 2014

by Max Fawcett

Investors have been waiting for a while now for a correction. They just might be on the verge of getting it. That’s because while the broader indices may be holding up, market internals are telling a different story. As Josh Brown noted on his blog a few days ago, market breadth – the performance of individual stocks relative to the index as a whole – appears to be breaking down. He cited market analyst Peter Boockvar, who wrote that “Monday’s close in the S&P 500 was just six points from the all-time record high close on April 2nd. But, on April 2nd 187 NYSE stocks reached 52 week highs vs 76 on Monday. On December 31st with the S&P 500 close of about 1850, there were 282 stocks closing at 52 week highs. Also, just 65 per cent of NYSE stocks closed above their 200 day moving average on Monday vs 74 per cent on April 2nd and 74 per cent on December 31st.” Meanwhile, the Russell 2000 small cap index closed below its 200 day moving average for the first time since November 2012, a potentially ominous sign for technically-minded traders.

Brown summarizes all of this thusly: “You don’t typically want to see large caps struggling at recent highs with less underlying participation by individual stocks – narrowing of participation at highs is how tops are formed. You also don’t typically want to see new all-time highs for the S&P while the more economically sensitive small caps are in a correction. These things can resolve in either direction, but the historical bias is toward a resolution to the downside.” This could be a blip on the radar, and an opportunity for this bull market to shed some weak hands before marching higher. Or, it could be a sign of trouble to come. And given the fact that it’s May, well, the prudent play might be to bet on the latter.

But if you’re bullish? You might want to open a position, or add to your existing one, in Legacy Oil + Gas (TSE:LEG). The company recently closed a deal with a private company called Highrock Energy for $200 million, one whose CEO we covered in April of 2010. The deal was done mostly with Legacy shares ($160 million worth) along with the assumption of Highrock’s debt, and it adds to its production in an area where it already operates and understands the geology. AltaCorp’s Don Rawson liked the deal, and thinks the company is an interesting investment at current levels, saying that “it continues to trade in value territory.”

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More important perhaps is the fact that the company’s management has signaled its intention to de-leverage the balance sheet, which is what is probably driving the discount on its shares. “We continue to believe that management is focused on a number of potential initiatives to improve the balance sheet,” Rawson wrote. “With this transaction announced, we believe that the most likely options that remain on the table are potential JVs or possibly a sale of royalty interests.” They have an outperform ranking and a $10.50 price target on Legacy’s shares, a decent premium to the $8 and change it’s trading at today.

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