Weekly Newsletter - Broad Market ETFs Firm at Support-Friday - June 23, 2006
First, we have an administrative note. The changeover happens today and the TDT Reportwill move. You can access this weekly newsletter (TDT Report) though the commentary linkon the ETFInvestmentOutlook.com home page. With the move comes a new name – ETFInvestment Outlook – and the primary focus will be on ETFs. This will include ETFsfor broad indices, styles, sectors, industry groups, commodities, currencies andinternational indices. I will continue to cover other market related issues includingbreadth, economics, sentiment, cycles and technical analysis. In the near future, I willalso start an ETF portfolio that will consist of 10-20 positions. With the new ProfundsUltraShort ETFs, it will also be possible to participate in market declines without usingshort sales.
Stocks surged on Wednesday and swooned on Thursday. The Nasdaq 100 ETF (QQQQ) gave backall of its gains, while the S&P 500 ETF (SPY) and Russell 2000 iShares (IWM) gave backmost of their gains. The blame went to rising interest rates and a weakening economy.Can’t say I blame the sellers. The 10-year T-Note Yield moved back to around 5.2% andis challenging its May high. On the economic front, the Leading Economic Indicators Indexfell and the 12-month rate-of-change shows that the economy is slowing.
The Leading Economic Indicators Index (LEI) declined sharply for the fifth time sinceMarch 2005. Except for one month, the monthly change in LEI was positive through 2002,2003 and 2004. Things started to change in 2005 and they are not getting any better in2006. The 12-month rate-of-change is on the verge of turning negative and this lastoccurred in November 2000. The next 23 months were not good for the S&P 500.
In addition to the poor showing from the Leading Economic Indicators Index, DurableGoods Orders came in below expectations on Friday. There is a clear trend underway forboth the economy and inflation. The latest batch of economic reports have been less thanstellar and this hints at some slowing. We have already seen the breakout in the ConsumerPrice Index and this clearly shows inflationary pressures.
Just to refresh memories, here is a chart showing the breakout in the Consumer PriceIndex. The combination of a stagnant economy and rising inflation means that investorsshould prepare for stagflation in the months ahead. That is where the indicators andcharts are pointing right now. A stagnant economy would be negative for earnings andstocks. Rising inflation would push interest rates higher and this would be negative forbonds.
What is one to do? Rising inflation should be bullish for gold and rising interestrates should be bullish for the US Dollar Index. While it may seem at odds to be bullishon both the greenback and bullion, the charts point to key support for gold and aconsolidation breakout in the US Dollar Index (breakdown in the Euro Currency Trust(FXE)). See the inter-market analysis section for details.
Turning back to stocks, the bulk of the evidence remains bearish. I have gone over eachof these in detail over the last few weeks and will simply recap the evidence. First, theMay-June decline broke key support levels in the Nasdaq and techs are relatively weak. TheS&P 500 and Russell 2000 remain in larger rising price channels, but have yet torecovery after the May-June swoon. Second, the AD Volume Lines broke key trendlines andmoved below their 50-day exponential moving averages. Third, Net New Highs expandeddramatically in June. Fourth, the VIX broke resistance in May-June and volatility is onthe rise. This means that fear and uncertainty are on the rise. Fifth, the four year cyclepoints to an important low in October and the six month cycle is bearish. That is theevidence and it is bearish until proven otherwise. Have a good weekend – Arthur Hill
Next Report: Friday 30-Jun
***Broad Market ETFs***
After the May-June decline, the broad indices became oversold and were trading nearimportant support levels. This combination could foreshadow a bounce or consolidation inthe days and weeks ahead. The May-June declines did a lot of technical damage and it hasyet to be undone. Most indices traced out falling price channels or wedges and have yet tobreak above their upper trendlines. The first step to a bullish reversal is to break thefall with a move above these trendlines. The second step is to break back above thesupport levels that were broken in May. Until this occurs, and with gusto I might add, theMay support breaks rule and they are bearish.
QQQQ reversed its uptrend with a sharp decline in May that broke key support at 40. Theindex is finding support around 38 from the August-04 trendline and October low (grayoval). This support zone argues for a bounce and there could be a move back to brokenresistance around 40. I would not consider changing my bearish stance unless QQQQ movesback above 40 on high volume and strong breadth. Otherwise, the support break dominatesthe price chart and sets the bearish tone.
SPX also broke down in May-June with a sharp decline to the lower channel trendline.However, SPY remains within a rising price channel and does not look as weak as QQQQ. TheOct-05 trendline and the 60-week moving average mark support in this area. The previousdeclines were reversed with a trendline break and sharp move back above broken support(green ovals). SPY would have to surge back above 128 to break the May trendline andrecover broken support in similar fashion. Unless this happens, I will remain bearish.
The S&P 500 Equal Weight Index (RSP) is the unweighted version of the S&P 500.As its name implies, all stocks are treated equally, regardless of market cap. RSP alsosuffered a sharp decline in May-June and found some support near 41. The 60-week movingaverage, broken resistance and Aug-04 trendline confirm support in this area.
Likewise, the Russell 2000 iShares (IWM) is also trading near support from the 60-weekmoving average, broken resistance and the Aug-04 trendline.
The Dow Diamonds (DIA) bounced off its lows this week and closed above 110. Some sortof bounce of consolidation was expected in this support zone (106-110) and that is exactlywhat we are getting.
It is clear from these charts, that these broad index ETFs are trading near importantsupport levels and we could see a bounce or consolidation in the coming days or weeks.Let’s see and judge the bounce before picking a bottom.
***Breadth***
The broad market breadth indicators remain bearish. The AD Volume Lines are movinglower after their May signals and new lows continue to outpace new highs.
For the Nasdaq AD Volume Line, I can now draw a red trendline extending down from theMay high. Selling pressure is clearly stronger than buying pressure as long as thistrendline and the 50-day exponential moving average hold. Also notice that Net New Highshave been largely negative since 12-May and thoughts of a strong rebound are ill advisedas long as Net New Highs remain in negative territory.
The same holds true for the NSYE AD Volume Line and Net New Highs on the NYSE. Weaknessin the Nasdaq breadth stats reflects weakness in tech stocks. Weakness in the NSYE breadthstats reflects weakness in the broader market and this includes the key Finance sector.
***Sector ETFs***
I remain defensive on the sector ETFs. The Consumer Staples SPDR (XLP), Utility SPDR(XLU) and HealthCare SPDR (XLV) are preferred over the Information Technology SPDR (XLK),Consumer Discretionary SPDR (XLY) and Finance SPDR (XLF). However, I am not thatenthralled with these defensive sectors. They are holding up well, but upside potentiallooks rather limited for Consumer Staples and Utilities. HealthCare has some more upsidepotential, but XLV has yet breakout and continues to show relative weakness. Let’slook at the three defensive sectors first.
While the market tanked in May and June, the Utility SPDR (XLU) worked its way higherwith a rising price channel. Overall, the stock remains in a large triangle with lots ofresistance around 33-34. As long as the market remains risk averse, the Utilities shouldcontinue to benefit and a move towards this resistance zone is expected.
The Consumer Staples SPDR (XLP) pretty much consolidated in May-June (gray box). Theability to hold support shows relative strength, but there is not much absolute strengthas the stock remains range bound. This is the kind of sector one buys near support (23),not close to resistance (24-24.5), and I will keep in on the back burner.
The HealthCare SPDR (XLV) moved slowly lower over the last three months and cannotbreakout of its falling price channel. It seems like this defensive sector would benefitin the current environment, but price action says otherwise and that is the main arbiter.A want to see a break above 31 before turning bullish.
A common pattern is taking shape for the remaining sectors. All were hit in May-Juneand falling price channels have evolved. The falling price channels are marked withmagenta trendlines and the current consolidations are marked with gray circles. Themajority of sectors remain within these falling price channels and it is impossible tohave an uptrend when this many sectors are clearly trending lower. As many sectors aspossible need to break the May trendlines to reverse the current decline in the broadermarket. Here are the charts with the annotations.
***Industry Group ETFs***
Needless to say, I am also seeing broad weakness among the industry group ETFs, TheTechnology related groups surged last week and consolidated this week. However, thesesurges were just oversold bounces and more is needed to reverse established downtrends.
The Networking iShares (IGN) fell apart in April, May and early June. There was anoversold bounce last week and then a consolidation over the last six days (gray oval). Toget any kind of bullish signal, IGN needs to break the upper channel trendline andconsolidation resistance at 31. As long as this holds, even a reaction rally or extendedoversold bounce is on hold.
The same is true for the Semiconductor HOLDRS (SMH) as the stock surged last week andconsolidated this week (gray oval). A move above this week’s high is needed to extendthe oversold bounce. However, the bigger trend is clearly down and I would expectresistance around 36-37.
Of the beleaguered tech groups, perhaps the Internet HOLDRS (HHH) holds the most upsidepromise. HHH led on the way down, but managed to hold its May low in June. The Nasdaq didnot and this shows relative strength. The stock bounced over the last seven day, but thisbounce pales relative to the prior decline. For aggressive investors, there is a bottompicking opportunity with the stock trading just above support. EBAY carries a lot ofinfluence in this ETF and should be watch closely as well.
***Inter-market***
I remain bearish on the Euro Currency Trust (FXE) and bullish on the US Dollar Index.There is not much change here. FXE failed to hold the breakout in early June and brokesupport at 127 a few days later. Broken support turned into resistance and it is holding.The first downside target is broken resistance around 123. Incidentally, the othercurrency ETFs will begin trading on Monday and I will add these to my watch list.
The corrective rally in the iShares ~20-year T-Bond Fund (TLT) ended with a sharpdecline over the last seven days. This decline broke the lower trendline of a rising flagto signal a continuation of the larger downtrend. There is still a lot of support around83 and the reaction high establishes key resistance at 86. With bonds moving further downand rates moving further up, there is little chance that the Fed will pause.
The StreetTracks Gold ETF (GLD) managed to firm over the last six days and even bouncedon Wednesday. As noted last week, I established a small position and set a mental stop at54.8. Due to volatility, I will refrain from setting a hard stop. The gap below 60 remainsunfilled and it would take a move above 60 to make this current gap an exhaustion gap. Inaddition, such a move would break the trendline extending down from the May high. I stillthink the long-term trend is up and there is lots of support around 55, which makes it agood bottom picking area. Support stems from the Feb-Mar consolidation and recent firmnessover the last six days confirms this support area.
The U.S. Oil Fund ETF (USO) continues to firm just above 65 and I remain bullish onoil. However, I am watching support from the June lows closely and will turn neutral on abreak below 65. A large triangle formed over the last nine months and this shows a massiveconsolidation. USO has been swinging up and down within this consolidation and the swingsince April has been down (black trendline). USO needs to hold support and break abovethis black trendline (68.5) to reverse the current down swing.
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ETF Investment Outlook is a weekly newsletter that is usually published everyFriday. Changes to the position table or model portfolio are sometimes necessary betweenpublications and special portfolio alerts will be issued by email and posted to thewebsite when necessary.
Disclaimer: Arthur Hill is not a registered investment advisor. The analysispresented is not a solicitation to buy, avoid, sell or sell short any security. Anyoneusing this analysis does so at his or her own risk. Arthur Hill andETFInvestmentOutlook.com assume no liability for the use of this analysis. There is noguarantee that the facts are accurate or that the analysis presented will be correct. Pastperformance does not guarantee future performance. Arthur Hill may have positions in thesecurities analyzed and these may have been taken before or after the analysis waspresent.
By Arthur B. Hill - Fri 23-Jun-06 13:28 PM
Stuck in a Rut
After big gains last week, a number of key sectors and industry groups have becomestuck in trading ranges this week. These ranges represent a post-surge consolidation thatcan actually be healthy. Big moves require a rest to regroup before a continuation higher.This is what a consolidation or trading range does. A move above the consolidation highswould signal a continuation of last week’s advance and this would be bullish. Failureto continuation higher and a break below the range lows would be bearish. Here is aselection of ETFs that are currently stuck in trading ranges. Many of these representimportant sectors and industry groups. As such, the direction the range break will have abig impact on the market overall.
By Arthur B. Hill - Fri 23-Jun-06 06:14 AM
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