Sunday, October 25, 2009

Technical Update 41.09

Another interim top has materialized. Like all of the other tops along the way, it will require a significant change in market character prior to allowing for confirmation of the primary top I am expecting. For the past few weeks I have outlined a number of factors that would help make this distinction.

1. Consecutive daily declines of 2.5% or more. This hasn't happened since the rally began (if so, only marginally).
2. Weaker internals than previously displayed during the rally via 10 day moving averages of a) put/call ratio b) advance/decline issues c) advance/decline volume.
3. A considerable increase in the US Dollar Index. A crossover of the 20 day EMA over the 50 day EMA is something that has not yet occurred since early April.
4. Divergence between major indices. Dow, S&P, Nasdaq, Transports, Banks. We should see significant divergence between some of these indices at a major top. There have been divergences present at various points, but they have quickly resolved themselves. Specifically, I am looking for underperformance in the transports, banks and/or the nasdaq.
5. A complete Elliott Wave '5' down on more than an intraday basis.

We are seeing early signs of divergence in certain indices, but not others. And market internals seem to be getting progressively weaker on any push higher. On an anecdotal level, I can sense mood shifting toward pessimism again. Earnings reports, while still very weak, have largely blown away analyst 'expectations.' Yet for the most part, this has not resulted in favourable reactions in the overall market. The US Dollar remains subdued, falling marginally with the market this week.

On March 3rd, I wrote about certain stocks and sectors that had been displaying relative strength in opposition with their November lows. Indeed, most of the stocks mentioned have enjoyed more than 100% gains from their lows. Of course, one would have done better buying some of the worst performing sectors, but picking the winners that experienced 1400% gains over those that only got 14% was impossible to determine at the time. Back in March, there was little that would suggest Fifth Third (FITB) would drastically outperform Keycorp (KEY), but momentum chasing of the former allowed this to happen.

I am currently tracking a list of stocks and sectors that are showing relative weakness to the overall market. Similarly, there may be greater downside potential found in those that have made the greatest gains over the past 7 months, but with those comes also greater risk. Trading in high beta sectors is a double edged sword. Below are some sectors that have failed to confirm the market's new October high. If I were looking for short opportunities, these sectors are where I believe the lowest risk will be found.

Transports and particularly the railroads have shown some of the most notable underperformance. For the week, both finished down more than 5%.

The solar energy sector topped in June and has been meandering sideways since then.

The biotechnology sector happens to be one of my favourites from a long term fundamental standpoint. But it is now also an underperformer over the past month, giving back more than 6% last week alone.

It is no secret that the problems with the banks are yet to be resolved. For much of the rally, bank share prices have been the leader in hopes that eventually "everything will work itself out." But they are not leaders any longer, showing weakness over the past two months and only able to marginally achieve new highs despite better than expected earnings numbers.

But weakness can be seen even more in Canadian financial institutions.

Another area that has received heightened attention by central planners is the housing market. It is believed by most contemporary economists that if home prices would just start rising again, then all the problems will go away. This comes from a fallacious interpretation of what went wrong last year, but it hasn't stopped them from trying all sorts of policies to fix home prices. Regardless, the homebuilding industry is now also displaying weakness. "You can't fool all the people all the time..."

Have a great week!

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occdude said...

Take a look at the inverse commercial real estate ETF SRS. This thing when it pops its gonna do a moon shot although the technicals look unimpressive as of late there appears to be a lot of support at the low 9s (multiple testings of that level resemble an airplane making a crash landing).

However, I am on technical analysis autopilot right now and not giving two damns about the fundamentals which should have validated this ETF months ago. Its good to see the end game, but we have a hand to play now. So if the market zigs when it should zag and the dollar goes up when it should go down, the technicals will rule the roost for me right now.

Not quite ready to go great bearish yet, but I'am "a nibblin". Agree with you on your analysis though, we are gonna have to see an equal but opposite reaction to all this trading momentum before the "bear goes all in for a swim".

Also, technically speaking, I think most people missed this inverted head and shoulders pattern with the market which is due to come into serious resistance at the 11000-11500 level ( I use the Dow number because I think it carries more emmotive power).

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