Market Wrap Up March 23/05

by Martin Goldberg

In Tonight’s Wrap Up, I’ll explore whether the latest stock market correction is one more head fake toward even higher prices, or perhaps something more ominous. The rally from the August ’04 lows moved like a bee-line straight through the presidential election and didn’t even correct until after the New Year. Following the rally into the New Year, the market corrected but the Nasdaq bounced from the “psychologically important” 2,000 level, while the Dow Industrials, S&P 500, Dow Transports, and S&P mid-caps bounced to new multi-year highs. Yet while the former bull trend must be respected, there are some technical factors, presented in this article, that may lead to the conclusion that this correction is not just one more head fake, but an ominous signal of a primary bear market trend.

Internet Holders (HHH) Lags the Market-Lagging Nasdaq

A previous article discussed the trend of the Nasdaq lagging the broader stock market in recent months. From the October 2002 bottom, the internet stocks such as those making up the exchange-traded Internet Holders (HHH) have led the Nasdaq 100, indicating traders’ appetite for high risk/high reward stocks. However, of late the internet holders have lagged the Nasdaq 100, and this is an indication that the stock market is becoming more defensive and less willing to take on risk - a bearish signal.

Nasdaq Descending Triangle May be Broken

The Nasdaq formed a descending triangle which appears to have been broken to the downside on Tuesday. If the support break becomes decisive, the price objective of the Nasdaq index would be about 1,850 as indicated in the chart. Yet as I draft this on Tuesday evening, the break of support cannot yet be considered decisive. What is considered “decisive” is subjective. Generally, a close of 3% below the support line or three consecutive closes below former support would suggest a decisive break of the horizontal support line. Until the break becomes decisive, a sharp and tradable rally is a legitimate risk for Nasdaq bears.

Notice that the index is sitting just below its 200-day moving average (red line) and a break below that line would be bearish from a technical perspective.

Big Nasdaq Rallies (Or Sell Offs) Rarely Occur Any More

Since the New Year, the Nasdaq has changed significantly in character in that it rarely produces a significant rally. Consider the following statistics. Between January of 1998 and New Year's 2005, the Nasdaq has produced a rally of 1.4% or greater, on average, once every 4.4 trading days, a little more than once per week. In all of 2004, there was an average of one 1.4% Nasdaq rally every 7.2 days. Yet since this New Year, we have had only 3 such Nasdaq rallies and have averaged only one such rally every 18.3 trading days.

Still, the change in the Nasdaq’s character is also illustrated by the less frequent selloffs as well. A 0.9% selloff occurred on average, every 4.8 trading days in 2004 compared to an average of every 8 trading days since the New Year.

The lack of either big rallies or sell offs is likely the result of hedge fund hedging than it is an indicator of future market direction.

US Financials Lagging

Financial stocks oftentimes lead the broader stock market. Below is a chart of the Dow Jones US Financials index. Note that it is challenging an uptrend after a steep and high volume selloff. Even though the uptrend is intact as of Tuesday evening, this is an ugly chart!

The Thursday Wrap Up two weeks ago discussed the US markets lagging those of other major economies. The following chart of the DJ US Financials versus the DJ World Financials (Excluding US) index indicating in clear and unbiased terms that something is consistently lagging in the US financial system versus the rest of the world. (When the trend is heading down as it has been since the spring of 2003, World Financials outside the US are outperforming those in the US.)

Fissures Not Repaired Readily – A Bearish Sign

The character of the market seems to be changing in that individual stocks are no longer able to recover from an apparent knockout punch. While I haven’t done a statistical study across the US market, I can tell you that this is a characteristic of several stocks that I have followed. For example, in ’03 and ‘04, knockout blows were absorbed by companies such as Eastman Kodak, Autozone, and Pep Boys on a routine basis. Yet after they gapped down in favorable general market conditions, each of these companies made miraculous recoveries. Similar behavior could be found throughout the stock market post October ’02 through ’04.

However, in recent months viscous selloffs have portended a more bearish intermediate fate for stocks. For example in October, the article entitled, “Chart Fissures Suggest Something Big is About to Happen” described selloffs in Fannie Mae, Countrywide Financial, General Motors, Pulte Homes, and AIG. Since that time all of these stocks (except for Pulte Homes) are either trading significantly lower than in October, or are in current steep downtrends.

I think that the premise of the article still stands – “something big is about to happen, and that something is bearish.”

Today’s Market

The latest market swoon was attributed to the rising price of oil, yet yesterday and today’s action saw oil take a tumble, with no corresponding rally. The major averages traded flat today, with some important sector leaders lagging such as mid-caps and transports. While the Dow, S&P 500, and Nasdaq finished little changed on heavy trading, the Dow transports finished down ½ of a percent, and the S&P mid-caps and small-caps each finished down about 1% each. Trading on the NYSE was extremely heavy, at almost 2.3 billion shares. Extreme volume with no progress to the upside is a bearish sign. The Nasdaq closed below the support line referenced above, yet the break of support is a subjective judgment call and I’m still skeptical as to whether the descending triangle has been broken (yet).

Following a rough open, the bond market caught a bid later in the day and I wouldn’t be surprised if the weekly job loss data released by the government tomorrow before the market open points to jobless claims that are slightly higher than economists’ expectations, thereby providing positive news for the bond market, which was spooked by the fed’s “english” on Tuesday. This economic news will not bad enough to hurt stocks that much.

Below, the 2-year line chart of oil shows that the steeper (up) trendline is being challenged. If it breaks that trendline, it could drop down to the lower trendline which is presently at about $46 a barrel. This would not be outlandish, and if it was to occur, it would make an ideal trading entry point to enter or add to energy related positions. Note that this has happened in July and December of ’04. For core positions, there is no relevance here. The long term chart shows higher lows and higher highs – the definition of a bull market.

If your position sizes are appropriate, then today’s sell off in oil stocks is not giving you any apparent mental stress….right?

The Central Fund of Canada (CEF), a closed end fund of gold and silver, pretty much sums up the precious metals scene at the moment. In anticipation of and following the Fed’s statement regarding short term lending rates, precious metals took a dive.

The CEF has given up almost its entire recent rally and this emphasizes the necessity of not “chasing” any stock or investment idea in spite of underlying fundamentals. For those without a position in precious metals, textbook technical analysis would suggest waiting for the current downtrend to turn back up, before establishing a position (with a logical stop loss) in precious metals. Let us not forget the long term trendline in gold, which is up as shown below.

The $CRB corrected as well over the last couple of days, giving back only part of the parabolic move to the upside that occurred over the last couple of weeks.

It seems to me that everyone is now looking for a bull market to buy and it is positively out of style to consider selling short at this time. Yet, there are pockets and sectors where the trends are decisively down and real profits can be made on the short side. Of course, as with any investment, an appropriate amount of caution is needed along with technical analysis and logically placed stop losses and position sizes. My tastes in this area run toward eclectic stocks with a lot of debt and weak sectors in confirmed downtrends. (Can you say Hummer?) As with chasing stocks up, never chase a stock down, either. Stay away from heavily shorted sectors and stocks as this will make you a sitting duck in the face of someone looking to flush you out by hitting your stops. But with that said, it seems like the time to short profitably (remember caution and logical stop losses) may be upon us.

Have a great evening.

Martin Goldberg

Martin F. Goldberg, MS, P.E.
Market Analyst
email mdelmgoldberg@comcast.net