Friday 24-Jun-05
12:00 PM ET
Editor: Arthur Hill
arthurh@tdtrader.com
http://www.tdtrader.com
Next Report: Tuesday 28-Jun-05
A long journey starts with the first step. With the sharp declines this past week, thecyclical bull market could be nearing its end. This would also mean that the secular bearmarket in the S&P 500 and Nasdaq is resuming. The major indices flashed short-termsell signals this week, but the medium-term signals have yet to come as support levels onthe daily chart are holding for now. These support levels are KEY to my long-medium termstance and I will change when these are broken.
A resumption of the secular bear market is not a comforting thought. Perhaps a sharpdecline will not ensue. Instead, we could be in for a long an grueling period of cyclicalbull and cyclical bear markets that last from 1-3 years. This is the kind of price actionthat followed the collapse of the Nikkei in 1990 and the collapse of gold in 1980. TheNasdaq bubble burst in 2000 and is may take many years of flag trading to digest thedecline from Mar-00 to Oct-02.
The S&P SmallCap Index (SML), S&P MidCap Index (MID) and Rydex Equal WeightS&P 500 Index (RSP) are not in secular bear markets as all recorded new all time highsin last week. However, these indices bore the brunt of selling pressure on Thursday andthe S&P Small-Cap EFT (IJR) shows plenty of resistance around 56. A bearish engulfingformed in March and a harami in June. Further weakness below 53.3 would confirm the haramiand argue for at least a support test around 49. A break at 49 would be most bearish.
With the broader market showing cracks, I am moving to an even more defensive position asfar as stocks are concerned. Selling pressure is picking up, sector rotations show noappetite for risk, sustained high oil prices are not positive for consumer spending andfalling rates are indicative of a weak economy. The current environment is not favorablefor stocks.
Position Summary
-Nasdaq Composite: Bullish with support at 2040
-S&P 500: Bullish with support at 1190
-TBond ETF (TLT): Bullish with support at 93
-US Dollar Index: Bullish with support at 85
-GLD: Neutral with support at 42 / 423
-XAU: Neutral with support at 84
-Oil: Bullish with support at 47
Have a good weekend -Arthur Hill
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Nasdaq: Last week I showed the monthly Nasdaq chart and pointed out thatthe index was at a make-or-break level (2050-2100). The index retraced ~25% of its priordecline (Mar-00 to Oct-02) and formed a rising wedge. The Jan-Apr decline broke the lowertrendline, but the index formed a monthly bullish engulfing in May to keep the cyclicalbull alive. This also marks the falling price channel breakout on the daily and weeklycharts. As far as I am concerned, this falling price channel breakout holds the key.
On the weekly chart above, the index still has a series of higher highs (2153, 2191) andhigher lows (1750, 1889). The string of higher highs could end with a lower high at 2106.A subsequent lower low below 1889 would definitively change the trend.
As noted before, 1889 is quite a long ways away and I would prefer to act sooner. Afterthe falling price channel breakout and May advance, the index met resistance at the 62%retracement mark and Feb-Mar highs (~2100). A consolidation formed with support at 2050and resistance at 2100. Resistance at 2100 is proving quite tough and I would not want tohang around on a support break at 2050. To try and prevent a whipsaw, I will employ a 10point buffer and turn bearish on a close below 2040.
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S&P 500: The long-term setup on the S&P 500 is similar to that on theNasdaq. The major difference is the size of the retracement. The S&P 500 retracedaround 62% of its prior decline (Mar-00 to Oct-02) with a rising wedge advance to 1229.Both the retracement and the pattern are classic for corrective advances within largerdowntrends.
On the weekly chart above, the index is holding the lower wedge trendline (blue). Advanceshave become quite difficult since the Mar-04 high at 1163 and upward momentum is clearlyslowing. The index broke the trendline extending up from Oct-02 (gray) and a lower high(below 1229) would not be positive at all. A lower high and move below 1136 woulddefinitely change the weekly chart/trend trend from bullish to bearish.
Cracks are starting to appear in the current uptrend. In fact, I would even say that anearly sell signal was generated with Thursday’s high volume decline. The index movedabove 1200, consolidated with doji and then dropped like a rock with a long blackcandlestick. The doji signaled indecision and the long black candlestick made the decision(down). RSI broke below the blue trendline and moved below its prior lows. These areenough for the early sell signal and confirmation would come with a break below 1190 SPXand 50 RSI. Technically, the index remains within a rising price channel and in anuptrend. However, notice that the RSI buy signal (2-May blue dotted line) came just belowthe actual breakout.
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Dow Theory: I talked about the Bollinger Band setup last Friday as the bands inthe Dow were at their narrowest in over 15 years. A break above 10600 and close above theupper band materialized on Friday. However, this was countered on Thursday with a sharpmove lower and close below the lower band. It was a classic fake and break. This bull trapand lower band break are bearish and I would now mark key support at 10660.
Before leaving the Dow chart, I would like to point out the support break and lower low inApril as well as the advance from late May to mid June.
The Dow Transports also formed a lower low and broke support in April. This is a DowTheory sell signal as both formed lower lows. The subsequent advance retraced 62% of theprior decline and formed a rising wedge. Yesterday’s trendline break and lower lowsignal a continuation lower and a move below the April low is expected. Also notice thatthe Dow Industrials moved to a new high in June, but the Dow Transports formed a lowerhigh. This key average is showing poor relative strength and this bodes ill forthe broader market. Why? Transportation (rail, truck and freight) is the backboneof the economy. Commerce slows when economic growth slows and this affects the transportstocks. They are kind of like a leading indicator.
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S&P 500 Sectors: Selling pressure has been broad based over the last 20 days.Only the Energy and Utility sectors came out unscathed with Consumer Staples, Industrialsand Materials leading the way lower. Energy, Utilities and HealthCare have been and remainat the top of the Power Score table with Weighted Averages at 90 or better.
The next three are the most important S&P 500 sectors: Finance, Consumer Discretionaryand Technology. All three are bunched up with Power Scores around 70. This favors thebulls, but the chart patterns at work are more ominous. All three are trading at importantretracements (62%), meeting resistance and showing vulnerability.
In a bull market, I expect the Consumer Discretionary and Technology sectors to lead. In abear market or defensive market, I expect the HealthCare and Consumer Staples sectors tolead. Comparing these four sectors reveals much about the current state of the market. Thechart above shows the S&P Consumer Discretionary Index and the S&P 500. Noticethat the S&P 500 moved to a new high in March, but the Consumer Discretionary indexformed a lower high. Both rebounded in May, but the negative divergence lingers and showsrelative weakness in this key group for 2005.
This next chart compares the S&P Information Technology sectorwith the S&P 500. The Information Technology sector peaked in Jan-04 and formed alower high in Dec-04. This created a large negative divergence as the S&P 500 movedback above its Jan-05 high in June. The Information Technology sector index remains wellbelow its corresponding high (blue lines) and shows relative weakness. Poor relativestrength by the Information Technology and Consumer Discretionary sectors shows a lowappetite for risk and this is negative for stocks overall.
As you can see from the chart above, the S&P Consumer Staples Index has heldrelatively firm in 2005 and came close to its March high in May. The index did fall shortof the March high, but shows more strength than the S&P Consumer Discretionary Index– its polar opposite.
Outside of Utilities and Energy, the real winner is the S&P HealthCare Index. TheS&P 500 failed to move above its March high, but the HealthCare Index moved above itsMarch high in May and remains above this high. It is not a runaway move, but it is clearthat this index is stronger than the S&P 500. Good relative strength in theHealthCare and Consumer Staples sectors confirms the low appetite for risk and this isnegative.
Before leaving the S&P 500 sector discussion, I will go over four key SPDR charts. TheConsumer Discretionary SPDR (XLY) failed to hold the breakout at 32.5 and declined sharplyon Thursday. This is quite negative and further weakness below 32.7 would signal acontinuation of the Jan-Apr decline.
The same holds for the Finance SPDR (XLF), which is the largest sector. The rising wedgeis a bearish pattern that usually forms as a corrective advance within a larger downtrend.There is a ton of resistance around 29.5 and a break below 29 would signal a continuationof the Jan-Apr decline.
As expected, the chart for the Information Technology SPDR (XLK) looks similar to theNasdaq. There is a lot of resistance around 20.5 from the 62% retracement mark and Feb-Marhighs. The stock broke falling flag resistance in mid June, but failed to continue higherand this is disconcerting. A shooting star formed on Thursday and a break below 20 wouldbe bearish.
I pointed out the breakout in the Materials SPDR (XLB) last week, but the breakout failedto hold. After moving above 28.5, the stock peaked and moved right down to support at27.5. The May-June advance now looks like a rising wedge and further weakness below 27.5would be bearish. Ugly.
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Nasdaq Groups: The Semiconductor HOLDRS (SMH) is trading at a majormake-or-break level and the cup is either half full or half empty. On the bearish side,the stock broke rising wedge support with the decline below 30 and then consolidated thelast 11-12 months. Broken support at 35 turned into resistance. A failure at 35 and movebelow 34 would be negative. A break below 30 would be long-term bearish.
On the bullish side, the stock broke above the black trendline and formed a higher low inJan-05. The rectangle consolidation (30-35) is neutral and a move above resistance frombroken support would be bullish. The stock pierced resistance this week, but failed tohold. Therefore, I am looking for a close above 35.35 to turn bullish and a close below33.5 to turn bearish.
The Internet HOLDRS (HHH) has a large head-and-shoulders reversal working with necklinesupport at 50. The left shoulder formed in Jul-04, the head in Jan-05 and the rightshoulder is currently under construction. It is also worth noting that the stock brokeconsolidation support on Thursday and is starting to show relative weakness. This makes atest of support at 50 more likely. A break below 50 would target further weakness below 30or to Nov-02 resistance.
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Gold: I am going to show three perspectives on gold with the actual commodity,the Phila. Gold & Silver Index ($XAU) and Newmont Mining, the largest gold stock. Goldlooks the strongest of the three on the price charts as it broke the Dec-04 trendline andis within spitting distance of its March high. In contrast, XAU and Newmont are trading atimportant resistance levels and remain well below their March highs. Talking about aconundrum.
Gold looks positive as broken resistance turned into support at 412 and held twice (Janand Jun). The recent surge broke above the upper triangle trendline, but gold needs tobreak above 444 to forge a new reaction high and turn the trend fully bullish.
XAU broke below the Jul-02 trendline with a sharp decline from mid March to early May. Theindex held its May-04 low and bounced with some serious vigor over the last six weeks.However, there is a lot of resistance around 95. A 62% retracement of the prior decline(104-78), the Jul-02 trendline extension and the Nov-04 trendline all converge to confirmresistance. I would be wary of new long positions above 90 with so much overheadresistance at 95.
Newmont (NEM) broke above the trendline extending down from Mar-05 with an advance overthe last six weeks. Notice that this stock has tracked the S&P 500 since March with adecline into May, a reversal in mid May and resistance over the last few days. There is alot of resistance around 40 from broken support and the 50% retracement mark. In addition,the bigger trend is still down as the stock trades below the Nov-04 trendline. As long aslast week’s gap holds (37.65), the uptrend since mid May is in place. A move below37.65 would fill the gap and argue for at least a support test around 35. I am stillsitting on the sidelines for gold and gold shares. The risk-reward ratio is not favorableand resistance levels lead to a pullback.
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Model Portfolio:
It was a bad week for the Model Portfolio as open positions sported a net gain of +5.87%last Friday and a net gain of +2.63% this Friday. General weakness and three specificstocks can be blamed (Seagate, CV Therapeutics and Alcoa).
Alcoa (AA) has been a disappointment from the beginning as the breakout at 28 failed tohold and the stock is on the verge of breaking its early June low. I will set a stop-lossat 26.3 and exit on further weakness.
Motorola (MOT) has held up relatively well, but is unlikely to buck the overall market ina broad decline. I would look to take some money off the table by closing 1/2 the positionand setting a stop-loss for the remainder at breakeven.
Applied Biosystems (ABI) gapped down on the open today and this position has moved from asmall gain to a small loss. Set a stop-loss at 19.9.
Wyeth (WYE) also weakened recently and broke below its June lows. Set a stop-loss at 42.3.
The decline in Seagate (STX) still looks corrective, but I am not riding it much further.The gap below 20 is holding and volume has been high. A move back above 20 would be quitepositive. Set a stop-loss at 17.9
Perhaps Bristol Meyers-Squib (BMY) is consolidating, but it has lagged the HealthCaresector in recent weeks and cannot hold gains. Set a stop-loss at breakeven (24.6).
Petrobras (PZ) has not participated well in the Energy rally and I will exit with currentgains.
Stone Energy (SGY) always manages to sell off after a surge. These sharp gains should holdand the immediate declines are disconcerting. As such, I will exit this position and booka profit.
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.This portfolio is meant for educational purposes and should not be considered arecommendation or 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.
