TD Trader Report 10/3/5
Started by
TTHQ Staff
, Oct 03 2005 10:09 AM
No replies to this topic
#1
Posted 03 October 2005 - 10:09 AM
Strength in the face of bad news is bullish, but I am not sure how much of thisbullishness is end-of-quarter window dressing and how much is sincere buying interest.That will become clear soon enough as the quarter ends today. Furthermore, there should bebullish follow through with expanding volume and good breadth. Show me the follow through.
Position Summary
-Nasdaq Composite: Bullish with support at 2100 (still holding)
-S&P 500: Bullish with support at 1200 (still holding)
-TBond ETF (TLT): Bullish with support at 91.88 (barely holding)
-US Dollar Index: Bullish with support at 85.5
-GLD: Bullish with support at 43.5 / 432
-XAU: Bullish with support at 93
-Oil: Bullish with support at 62
***Major Indices***
Most of us are aware of or have at least heard of the four year cycle and the presidentialcycle. Since 1942 there have been 15 four year cycles in the S&P 500 and we arecurrently in the 16th. Each four year cycle contains a bull cycle and a bear cycle. Theaverage length of the bull cycle is ~3 years and the average length of the bear cycle is~1 year. The average bull market gain is 93% and the average bear market loss is 26.4%.This is pretty standard information that can be obtained from numerous research papers andthe Stock Traders Almanac.
The four year cycle is shown here for the S&P 500 since 1970. The indexconsistently recorded a low every four years (plus or minus a few months). It is simplyamazing how well this worked and the last low was in October 2002. This means a new fouryear cycle began in October 2002 and is scheduled to end in October 2006.
The current bull market will turn three in October 2005 next month. The averagebull cycle lasted three years and this suggests that the current bull is quite mature.Bull markets are not like fine wine. They grow thinner with age and it gets increasinglyharder to make money as fewer stocks advance and more stocks stall.
This next chart shows the S&P 500 Equal Weight Index and the four year cycle. Thelows occurred every four years in October and in the second year of a presidential term.There are lows in 1990, 1994, 1998 and 2002. The second year of President Bushs termis 2006 and this jibes with the four year cycle. Based on the four year cycle, the averageage of a bull cycle and current sector rotations, investors should expect a top and adecline through the first three quarters of 2006.
Cycles serve to alert investors and traders of upcoming changes, but we must still relyon the price charts for concrete timing. My eyes are on the broadening formation in theS&P 500. After a big run above 1200 at the end of the year, the S&P 500 turnederratic in 2005 and formed a broadening formation. These are bearish patterns and I amwatching support at 1200 for confirmation. A move below 1200 would turn the trend in SPXbearish and the downside target would be the lower trendline extension of the broadeningformation. This trendline (black) extends to around 990 by October 2006. The average bearmarket decline was 27.4% and a 27.4% decline from the 1246 would extend to around 900(1245 x 27.4% = 341, 1246 341 = 905). It makes little difference if the decline is20% of 27.4%. Such a move would leave few stocks unscathed.
The current chart pattern/setup in the Russell 2000 ETF (IWM) is similar to that seenfrom January to April. After a sharp advance, IWM peaked in January and formed adescending triangle (magenta trendlines). The support break at 60 was bearish and thislevel turned into resistance in May. The stock firmed and broke back above 60 (resistance)in May and charge to new highs. Currently, IWM is testing support at 64 and it looks likethe early April periods (black caret). A support break at 64 would be bearish and open thedoor to 60 again.
Small-cap, mid-cap and tech stocks usually have higher betas than large-cap stocks andwill lead both advances and declines. For example, General Electric has a beta of .83 andNvidia has a beta of 3.34. The market beta is 1. In general, stocks with a beta below 1are less volatile than the overall market and move less than the market. Stocks with abeta greater than 1 are more volatile and move more than the market. If the market is up10%, I would expect GE to be up 8.8% and NVDA to be up 33.4% (roughly). The converse istrue on the downside. If the market is down 10%, I would expect GE to be down 8.8% andNVDA to be down 33.4%. No matter which way the market moves, small-cap, mid-cap and techstocks will lead. If a general market decline ensues, expect the small-cap, mid-caps andtechnology based indices to lead the way lower.
I am still quite concerned with relative weakness in the Nasdaq and tech stocks over thelast two months. The NYSE Composite is trading back above its August high, but the Nasdaqremains well below its September and August highs. I dont like to see Technologylagging the broader market because this shows risk aversion.
The Nasdaq remains in a clear downswing that could be a correction at best and thestart of a big decline at worst. One thing is for certain: the swing is firmly down aslong as the upper trendline holds. A bullish setup is there with a 38% retracement of theApr-Jul advance, return to broken resistance and falling price channel. However, a strongcatalyst off support is needed to muster the strength required for a breakout at 2200.Thursdays advance was impressive in price, but a big short on volume and I want tosee more before considering this downswing over.
***Breadth***
Breadth deteriorates in the latter stages of a bull cycle. As noted above, the currentbull cycle is three years old and getting quite mature. And just like old cheese, breadthin the latter stages of a bull cycle starts to stink. The AD Line for the S&P 500 keptpace with the index pretty well until this month. The AD Line formed a lower high in midSeptember and broke below its June low on 21-Sept. The lower high shows that fewer stocksare participating in the advance. The support break shows that more stocks areparticipating in the decline. In addition, the AD Line broke the trendline extending upfrom March 2003, which pretty much captures the entire bull cycle for the index.
I have often mentioned the NYSE Composite and the S&P 500 Equal Weight Index (RSP)because these broad indices continue to forge new highs. The NYSE Composite is a marketcapitalization weighted index of some 3400 issues. There are a number of preferred sharesand regional banks, but it is still a good index and breadth counts.
The AD Line kept pace with the index from April to September as both rallied to newhighs. Both declined in early September and the NYSE Composite held its 50-day EMA.However, the AD Line broke below its 50-day EMA and below its August low. The AD Line nowshows more weakness than the NYSE Composite. As with the S&P 500 AD Line above, thisshows few stocks partaking on the upside and more stocks partaking on the downside.
***Sector Overview***
Should the four year cycle play out and should stocks decline over the next 6-12 months, Iwould expect the defensive sectors to either decline less or even modestly rise. Bearishcycles are called bearish cycles because most stocks go down. Sorry for stating theobvious, but 80% of stocks decline during such periods. I would look for the Technology,Consumer Discretionary, Industrial and Materials sectors to get hit the hardest.Conversely, I would expect the Consumer Staples and HealthCare sectors to hold up thebest. These are traditionally defensive sectors that perform best in times of turmoil. Nomatter what happens to the economy we still need our bread, beer, toothpaste and medicine.Ok, maybe we can do without the beer, but it sure is nice after a long day at work.
The Consumer Staples SPDR (XLP) looked like it was on the verge of a breakdown lastweek, but recovered from the gap and surged above 23 this week. The gap becomes a bullishexhaustion gap and support at 22.4 has been reinforced. Longer term, the stock remains ina large trading range and we need a breakout at 23.7 to turn long-term bullish again.Procter & Gamble (PG) is a leader in this sector and the stock broke to new highs thisweek.
The HealthCare SPDR (XLV) declined sharply over the last few weeks, but the long-termuptrend remains in place. It is tough to sit through such sharp declines and the depth ofthe decline is enough to question the September breakout to new highs. However, the stockfirmed on Thursday and there is a lot of support around 31 from the lower trendline andthe prior lows. I am going to give this sector a little leeway and will not become overlyconcerned unless there is a close below 31. A move above 31.7 would break the short-termdowntrend and call for further gains.
***Inter-Market***
The US Dollar Index broke the upper trendline of a falling flag last week and resistanceat 89 this week to signal a continuation of the prior advance. The falling flag is abullish correction pattern designed to allow for profit taking or to alleviate anoverbought condition.
This one played out to perfection and the breakout should be considered bullish untilproven otherwise. Watch 87.5 for signs of a breakout failure and key support at 85.5 toturn bearish on the greenback.
Despite the September rise and breakout in the US Dollar Index, gold and gold stocksremain bullish. However, both are overbought and turning quite volatile. This is notenough reason to turn bearish, but does increase the odds of a correction or a pullback.
The StreetTracks Gold ETF (GLD) established support at 45.5 with abounce this week and a move below this level would call for a correction back towards44-44.5. Broken resistance and a 50-62% retracement of the Jun-Sep advance confirm supportin this area. I am setting key support at 43.5 and will consider the Aug-Sep trianglebreakout dominant and bullish as long as this level holds.
Model Portfolio: I am concerned with RSA Security and Bristol Meyers.RSAS declined on Wednesday and Thursday to test support at 12.5. A close below this levelwould not be welcome and I would then consider removal from the Model Portfolio. BMYdeclined over the last three weeks and is testing support at 24. There is a lot of supportin this area and I will be watching price action closely as it makes a test. The surge inthe Nasdaq 100 (QQQQ) is also on my mind as the index held support and turned short-termbullish. This position was based on the descending triangle, bad breadth and lastThursdays gap down. The gap has been filled, but the descending triangle and badbreadth remain. This also acts as a hedge for the long position in RSAS and MOT. As such,I will keep it on for now and see how the market acts after the quarter ends today.
Model Portfolio Notes: L = Long Position, S = Short Position, Qty =quantity of shares, REC = Re-evaluation close (close below REC for longs and close aboveREC for shorts), SL = stop-loss. This is a hypothetical portfolio based on even dollaramount of $10,000 per position. $20 was subtracted to cover round trip commissions. Thisportfolio is meant for educational purposes and should not be considered a recommendationor solicitation to buy, sell or short these securities.
about: The TDT Report consists of a brief update on Tuesdays and a fullreport on Fridays. For shortened weeks (4 days or less), there will only be one report onthe last day of the week. Changes to the Model Portfolio and major indices are sometimesnecessary between scheduled updates (Tuesday and Friday). As such, additions, deletionsand/or updates to the Model Portfolio may sometimes be emailed between reports. These willalso be added to the website.
Disclaimer: Arthur Hill is not a registered investment advisor. Theanalysis presented is not a solicitation to buy, avoid, sell or sell short any security.Anyone using this analysis does so at his or her own risk. Arthur Hill and TD Traderassume no liability for the use of this analysis. There is no guarantee that the facts areaccurate or that the analysis presented will be correct. Past performance does notguarantee future performance. Arthur Hill may have positions in the securities analyzedand these may have been taken before or after the analysis was present.
Power Score: The Power Score (PS) is based on absolute strength and thiscan be compared against other securities for an idea of relative performance. The PowerScore (PS) measures the strength of a particular security for a given time frame: 20-day,60-day, 120-day and 250-day. These are trading days and roughly equate to 1, 3, 6 and 12month periods. A weighted average of the four Power Scores is then calculated with12-months weighing the most and the 1-month weighing the least. In general terms, readingsabove 55 are bullish and readings below 45 are bearish. The zone between 45 and 55 is atransition area that can go either way.