Rotation, Rotation, Rotation
By Frank Barbera CMT. February 5, 2008
At times like these in the capital markets, where volatility resides at very high levels, capital will frequently rotate quickly from sector to sector. Over the last 5 to 10 days the financials, the REITS, and the Homebuilders have been the leadership for the stock market, all of these groups bouncing off of what was a deeply oversold value. Yet, a quick look through some of the sector charts shows that these sectors, after enjoying a sizeable bounce, are now back to overbought condition. In the chart below, we see the Relative Strength Ratio of the Banking Sector versus the S&P 500 with the recent bounce moving the group back up toward resistance at the declining 100 day, or 20 week moving average. In addition, the 14 day RSI has also very quickly moved back up to the fully overbought threshold near +68 to +70.
Above: Bank Stocks versus the S&P 500 – Relative Strength Ratio Upper clip and Wilder 14 day RSI on R/S Ratio lower clip.
Above: the GST Homebuilder Group with Medium Term ARMS.
Likewise, the Homebuilders have also moved back up to a fully overbought condition after enjoying a nearly 50% bounce off the oversold lows. As of yesterday's close, the medium term ARMS Index for the Homebuilders was well below the .70 lower overbought threshold on the ARMS Index. Looking back at the course of the bear market, these types of very low ARMS Index readings have been associated with important peaks for the sector. Thus, the need to remain nimble and to key money working in oversold sectors. So what's still fairly oversold right now? Well, perhaps chief among the oversold victims is our battered currency, the US Dollar, which looks about as oversold as it has been at any time during the last 40 years.
Above: GST Long Term Overbought-Oversold gauge US Dollar Index.
While it is quite counter-intuitive given that the Fed is cutting rates, the argument for a near term Dollar rally centers on the view that the aggressive Fed easing will stimulate the US Economy first, with the hawkish ECB allowing the European economy to suffer a longer period of economic contraction. While I am a long way from convinced that this argument makes real sense, it is the train of thought which the currency market has adopted over the last few days. Very often, when a market is oversold and ready for a bounce, the "excuse" for a rally materializes, and sometimes from the strangest places. In this case, a bouncing US Dollar is bearish for the commodity complex, and of course, the opposing currencies, all of which have enjoyed a huge advance. On the positive side, we could see a bounce in European ADR's trading here in the US, of which are badly oversold. In last week's report, we noted that the Big Pharma sector was oversold, and within Big Pharma, there are many large European Drug makers that are currently monumentally compressed. Will a Dollar bounce and a downside correction in the Euro be the much needed "excuse" for these share prices to rebound? Only time will tell.
Above: the GST Consumer Index and the Medium Term ARMS for Consumer Stocks.
Yet another area which is currently pressing a serious oversold extreme is the Consumer Non-Cyclical Index. These are the so called "recession proof" companies which right now are, ironically enough, deeply oversold. What in this group? Well, the big soap manufacturers, detergents, shampoos, etc., the large cap Soft Drink companies, along with Cosmetics, and Food. All deeply oversold and in my view, with major support close at hand, very ripe for a potential recovery bounce in the weeks ahead. Running a quick sort through oversold readings for our sector of 25 issues we found that Pepsico (PEP) and Anheuser Busch (BUD) turned up among the most depressed at the current time. For nimble traders who know how to protect their positions using stop losses, conceptually, deep oversold values like this can be helpful in establishing risk taking parameters.
Above: Budweiser - Busch Beer, very oversold with major support near $47.
Of course, any bounce in an individual sector is always going to be dependent on overall market conditions and the trend of the broad stock market. So what's next for the US Market? As I see it, looking ahead at the near term trend for the US Stock Market, we still see the "weight of the evidence" in favor of the bulls, despite today's downward market action which was most definitely not a step in the right direction.
Overall, last week's market did a very good job of climbing the "wall of worry" and advancing against a steady tide of negative news (Google, Amazon, the Monolines, etc.). This is usually an indication of a market that wants to move still higher, and with the Fed opening the spigots, the old Marty Zweig tenant of "Don't Fight the Fed" comes to mind. In addition, in looking for clues and near term directional guidance the same 10 day / 50 day moving average combination (discussed for Gold earlier) is also of interest for the S&P at this time.
Back on November 8th of 2007, the 10 day average closed below the 50 day average at the conclusion of the Sept – October rally. Since then, the 10 day has remained solidly below the 50 day average, which is shown in the chart below. In the upper clip, we show the S&P with the moving average combo, and then, in the lower clip, we show combination as a spread, with the 10 day moving average subtracted from the 50 day average. As the oscillator clearly shows, the pair has been in negative cross-over mode now for nearly 3 months. More specifically, through Friday, February 1st, the 10 day/50 day oscillator spread has been negative for 58 trading sessions, which going back over the last 37 years to 1/1/70 is long enough to qualify as a maturing and overdue Time Span. Over that period of time, there have been about 15 separate occasions when the 10 day average remained below the 50 day average for 60 days or more. As of Friday, the 50 day average closed at 1429.73, with the 10 day average at 1350.30 with the 50 day average falling at approximately .70 points per day, while the 10 day average is now rising 6.02 points per day. The S&P closed Friday at 1395.40 or about 34.33 index points below the 50 day average. Assuming that the S&P remains on balance in rally mode over the next week or two, it is very hard for us to see how the positive cross-over would take place without the S&P moving up into at least the mid 1400 zone, 1420-1450. In addition, it is also hard to see, using the present rates of change on each moving average, how the market will attain a cross-over in a period less then 8 to 10 trading days.
Above: the 10 day versus the 50 day moving average oscillator for the S&P 500.
Thus, in our view, this analysis hints that (a) stock prices should be headed higher toward the mid-1400's, and (b) the rally probably has at least another week if not a bit longer to run. In addition to the 10 day - 50 day MA Combo, the S&P 9 day RSI has NOT seen substantial OVERBOUGHT figures in some time, through Friday a period of 185 trading days wherein the S&P has NOT generated a 9 day RSI value above +74. To achieve this kind of reading over the relatively near term, a stronger advance would be needed, with prices likely moving into the upper 1400's in order to generate such a value. While that may seem to be beyond reach at the present time, today's down market did reinstate a near term oversold condition in the stock market which should act as a catalyst for further recovery in the days just ahead.
Above: the S&P, the 10 day - 50 day spread oscillator, and the Time Span Counter, Days with 10 day average below 50 day average (bottom).
Above: the S&P (above), the 9 day RSI (middle) and the Days without a 9 day RSI value above +74 T/S Counter (bottom).
Elsewhere, it is worth noting that if we look at the charts of other world markets, the recovery thus far is almost negligible with markets like Germany, France, Tokyo and Hong Kong still much closer to their lows.
Below: the Hang Seng Index in Hong Kong would need to reach 26,700 to retrace 50% of the prior decline, and 27,900 to retrace a Fibonacci 27,900.
Above: Hang Seng Index - weekly chart.
Above: Tokyo's Nikkei 225 would need to recover to at least 15,400 for a 50% retracement.
While there are never any guarantees, given the 20% type declines seen in recent weeks, a counter trend rally lasting several weeks and sizeable enough to show up on the Weekly charts would seem to be a reasonable estimate. For the S&P 500, the key resistance near term is 1407 to 1410 and any move above that would be bullish. On the downside, given the current levels of still high volatility, the 1320 area is now the strongest nearby support zone, and is likely to hold any additional near term downside slide should one develop. While I do not expect a break below 1320, should it develop it would be very bearish and would suggest a full retest of the lows at 1270. Any move below 1320 would also be an unequivocal sign of a market heading for much larger problems, so 1320 would be THE key exit point where the stock market is concerned.
Markets plunged today with the S&P 500 down 44.18 points to finish at 1336.64, the DJIA ended at 12265.13, down 370.03, and the NASDAQ lower by 73.28 points, finishing at 2309.57. The 10 Year Bond yield closed at 3.57% and Gold finished down 14.99 at 888.58. That's all for now,
© 2008 Frank Barbera