Securities Research Services

Friday, July 28, 2006

Lead Dog QQQQ Still Leads Lower

The QQQQ found resistance at its pivot point (middle of the downtrend channel) and turned sharply lower yesterday. This created a bearish engulfing signal, and as the name implies, it is bearish. Since the QQQQ has been the market leader on this downtrend, it will also be the best indicator of when this downtrend is ready to provide a significant relief rally. We have had a few teaser rallies over the last few weeks, but nothing that lasted more than a few days. We suspect that as the QQQQ reaches down to its lows, and perhaps even makes a new low, that sentiment levels will once again reach extreme. We also suspect that we are very near a strong relief rally and that buyers will be soon stepping in to the consternation of overly confident bears. This is still a market to be short in, but it is also a market for the nimble. Next week we may have an opportunity to participate in a strong upside move if we can get the right mix of decent earnings reports and too many bears with their hands in the honey jar.

Thursday, July 27, 2006

Tech May be Forming a Bottom

Breadth in the tech sector was good yesterday, indicating that we may be nearing a bottom. However, buying power has likely been used up in this latest rally off the floor, making it likely that the QQQQ will see a return to its lows before it can move significantly higher. If however the QQQQ insists on trading up back above $37 without a significant pullback to help it establish a better base, we will be forced to start shorting again as a move higher from these levels will be unsustainable.

Wednesday, July 26, 2006

Yesterday's Rally Likely to be Short-Lived

Yesterday's follow through day has a lot of bulls thinking recovery. The problem is that indices are once again near stiff resistance. It's not a good idea to make too much about yesterday's trading. Buyers could potentially come in and buy stocks up past support, but the probabilities are slim that this will happen. Moreover, without a decent base from which to rebound, a move higher is likely only going to attract more sellers and cause another steep drop.

Tuesday, July 25, 2006

Recovery Effort Weak Thus Far

Sentiment did indeed keep a floor under the market yesterday, but the bounce has thus far been uninspiring. What we are seeing so far is more indicative of consolidation as stocks work off their oversold conditions by trading in a narrow range than it is of a recovery effort. After such a steep sell off, we are quite likely to see at least one more wave down before sellers decide to take profits and buyers find the nerve to reenter the market in force. Our projections show that we could see the QQQQ drift slightly higher over the next week or two, while the blue chips trade in a sideways range. Unless we see serious volume come in and see an upside breakout that sticks in the blue chip sector, we need to call a club a club and admit that we are still in a downtrend. What does that mean exactly in practical terms? It means that rallies should be sold and that stocks should not be chased.

Monday, July 24, 2006

Overbougth Levels Could Spark a Rally

Sentiment levels are nearing all-time-high bearish levels. This should keep a floor in the market at current levels. It is also interesting to note that oversold levels and the weekly trading patterns in the QQQQ are now nearly identical to the week of August 9, 2004. If indeed we have a bottom in place, a rally out of this hole could potentially be quite significant. The tell will be how strong the bounce is. If the market fails to bounce and/or it bounces weakly, we may be looking at more downside. If we can get a good broad market rally on good breadth this week or next week, then we may be in for a very nice recovery. To be sure, it is too late to short in all but a few sectors.

Friday, July 21, 2006

A Better Oversold Rally is Nearing

Options expire Saturday so expect more meaningless trading today as options sellers attempt to work stocks into their maximum pain points. The QQQQ dropped lower once again yesterday, but frankly we wouldn't trust a breakdown at these levels. A break lower is likely to lead to a strong intraday reversal and should signal the beginning of a decent countertrend rally that will last more than just one day. Gold has done a fairly good job confirming that a top is now in and so it should be considered to be trading in an intermediate downtrend now. Any bounces should be sold into in this sector; baring off course a strong reversal due to a serious erosion of Middle Eastern stability (unlikely). Likewise, oil stocks are continuing to experience real pressure, even as the price of oil holds above $70. We wouldn't short oil here, but we would avoid buying it at this time.

Thursday, July 20, 2006

Yesterday's Bounce Likely to be Short Lived

Yesterday was likely the only day that it was safe to enter for an oversold bounce. The trend is still down and the market leaders, QQQQ and SMH were both essentially just pulled along in yesterday's rally; as opposed to leading the way, which is what the market leaders should be doing if this recovery were legitimate. Ideally we will see the QQQQ come back up to just above $37 before it finds resistance again. It has room to vacillate for a few days before running into the downtrend resistance line, as you can see in the chart below. With options expiration on Saturday, that is exactly what we would expect the market to do; vacillate with a slight upward bias. It is best not to get overly aggressive in front of options expiration. Price movements will be less meaningful over the next two days. Settle in with your open positions and wait for stocks to bump back into resistance for a good set up.

Wednesday, July 19, 2006

Tech May be Ready to Run

The tech sector is close to staging a bounce. Negativity in the sector is at overly bearish sentiment levels and technically the sector is very oversold. It's not reasonable to look for more than a counter trend rally at this time, but a rally in tech could potentially run strong for a few days and is worth buying a few shares to participate in it.

Tuesday, July 18, 2006

Significant Low May Occur Next Month

World events are creating artificial conditions for a steep market sell off. These events have an artificial impact, because the correlation between the US economy and events in the Middle East, is somewhat dubious. Nevertheless, we have been looking for a significant market bottom sometime later this year, but with the perception that risk must be priced into the market based on unsettling world events, we may in fact get a significant low as early as the next few weeks. The four-year cycle low, we wrote about yesterday will still likely put pressure on the rebound from our upcoming significant low, but with this hard sell off, the four-year low could actually come in the form of a double bottom or even a higher low. In other words, we are very likely nearing a long term buying opportunity. For now though our focus must remain on what is right in front of us, not what could be around the corner. For now the immediate trend is down and this will impact the performance of most stocks in the market. Rallies are likely to get sold and oversold will likely continue to become very oversold until we see capitulation. When will capitulation come? It will come when it comes, no sooner, no later. It is best not to try and guess, but rather to trade with the trend.

Monday, July 17, 2006

Relief Bounce Likely, But Not Likely Sustainable...Yet

The market is oversold and due for a relief bounce. Keep in mind that any relief bounce should be shorted into at this point. Investors who were late exiting before this latest leg down in the sell off will be looking for better prices to exit. This will keep pressure on the market. Right now the market is in a confirmed intermediate downtrend. Until genuine capitulation takes place, the best policy will be to use the rallies to enter short positions. Currently we have a hypothesis about how this downtrend will play itself out. The QQQQ is trading in what looks to be a measured move pattern at this time. This means that the current leg down should run in equal length to the last leg down, from $42.00 to $38.50. Using the measured move hypothesis, we should see the QQQQ trade down to $35.00 before a sustainable rally can ensue. $35.00 also represents the next level of weekly support. Once a sustainable rally gets moving, it is possible that we could see a strong move up over the next month or two, perhaps even moving so far as to tag the broken support line at $39.00. Now, keep in mind that the 4-year cycle low is expected somewhere around November of this year. Thus, after the next sustainable rally (not to be confused with an expected one or two day bounce we are looking for this week), the market is likely to turn down again heading into November. November is expected to mark a significant buying opportunity for long term buyers. The trading opportunities heading into the 4-year cycle low should be nothing short of fantastic. Today we recommend not entering any new positions while we wait for the market to work off some of its oversold conditions. A lot of Friday's selling was an unwillingness to hold over the weekend in face of the ME crisis. Pressures should abate some as we start the new week.

Friday, July 14, 2006

Ignore Any Bounces, This Slide Has More Ways to Go

Once again options traders are overly bearish. Yesterday's instability in the Middle East forced the market lower despite the overly bearish posture amongst the masses. Nevertheless, we should see a bit of a floor today, if only a temporary one. The market is confirming the 39-week cycle low, which is projected to land toward the end of the month. It is doubtful that we will see a meaningful reversal until it lands. Any strength in the interim should be aggressively shorted. The strange thing about yesterday's market was the sudden disconnect between oil stocks and the price of oil. With oil soaring past $78 overnight though we should see strength return to this sector today.

Thursday, July 13, 2006

Tech Weakness, but Too Many Bears Make a Minor Floor

Options traders on the QQQQ are overly bearish, so we should see some of yesterday's weakness reverse today. Nevertheless, the tech sector is weak due to fed bank policies in Japan and fears of further weakness do not appear to be going away anytime soon. As such, institutional money will probably keep on selling the rallies as they seek to sell down their inventories to the sleeping point (the point which they can sleep easier). The market is really in a state of indecision at this point. Selling pressures have abated somewhat, but buyers are certainly not rushing back in. There remains a lot of uncertainty related to future rate hikes and upcoming earnings. We would continue to short bounces in tech and consider a few longs in commodities. Cash is a good place to be heavy in though until next week when some of the question marks overhanging the market find resolution. Technically one of the bigger question marks is will we get a bounce prior to a hard move down into the expected 4-year cycle low, or will the market drift and then plunge, or will we get a tradable rally that then sets up for a bigger drop. With such widely contradictory possibilities, it makes sense that the market is confused right now.

Wednesday, July 12, 2006

Shelf of Distribution

In yesterday's report we outlined our thesis arguing that the market was under extreme distribution, but that shorts would likely be shaken out of their positions before the market turned significantly lower. Yesterday's late afternoon rally fits the thesis and if we are right, we will see the QQQQ rally sharply higher over the next few days to fill the gap near $38.90. The pros call this process "creating a shelf of distribution." It is to the benefit of institutional money to exit their positions at higher, rather than lower prices. If they can get the market to work its way higher buyers will create their own self-perpetuating momentum. This type of trigger tends to exhaust itself quickly since smart money uses the momentum to sell into. There continues to be evidence of distribution as money flow figures on some major sectors are turning down as prices turn up. Using this momentum to sell into appears to us to be the highest probability play. Understand that we, or anyone else, do not actually know what is going to take place in the market. The market is all about probabilities. Our work shows that the highest probability play will be to sell into this minor rally we expect will take place over the next few days. If we are wrong we will see stock set ups start to improve. The downtrend is still in effect and there is no money to be made in calling an exact bottom. If the trends turn back higher, there will be plenty of time to go long again as stocks back and fill to build support. It will be interesting to see if the market can rally sharply higher today the way it did on 6/15 and 6/29. Note the fact that after those two rallies distribution took place and no real follow through was realized. There does not appear to be any sense in grabbing long exposure for a one day rally (if it is to play out like this yet again). We will do better to sideline ourselves today and look to see what develops today and perhaps tomorrow. Options expire on Friday, making any rally equally suspicious at this juncture. The bottom line: This market is not providing high probability set ups and due to its one-day-up, one-day-down nature, the chances of getting whipsawed are very high.

Tuesday, July 11, 2006

Market Correction Setting to Continue

At the end of June the S&P 500 and Dow both rallied strongly over their downtrend lines indicating that the market correction had played itself out. Unfortunately the NASDAQ was not able to rally quite so far and while the blue chip indices have been holding up, the tech-heavy NASDAQ has been bleeding off. Likewise, the lead tech sector, the semiconductors, has proceeded to break down to even lower lows. All last spring the tech sector led the market lower as it underperformed. Now it is once again underperforming and the fact that we have not seen a strong follow through rally develop indicates that the market recovery attempt has failed. A slew of stocks continue to trade at 52-week lows and bounces have found distribution over the past few days. There is some indication that we will see one more thrust higher. The QQQQ has an open gap at $39, which could possibly fill. Likewise, it seems unlikely that the QQQQ will follow through lower after 4 days in a row of downside already at its back. The scenario we see possibly developing then is a sharp up move, which would stop out overly eager shorts, followed by a crumbling downturn. Due to the amount of distribution we have seen over the past few days, a downturn now could leave the market grasping for a floor only to find an air pocket below. In other words, This is a market for traders and traders should probably be easing into short positions on the bounces. Those holding intermediate long term positions should probably be in cash at this point.

Friday, July 07, 2006

4th of July Rally Fails to Garner Buying Interest

The lack of buying interest this week has been troubling. Equally troubling is the continued underperformance in the tech sector. This is exactly the same picture we saw in late spring of this year before the market took a turn for the worse. Since the market has not made a strong recovery off the recent lows we can only assume that the downtrend started in May is still in effect. Today's employment report is expected to come in with large numbers. The market will likely react harshly to a "good" employment report as they expect that the Fed will be forced to continue raising rates. The problem is that rate hikes have already impacted the outlook for the economy in 2007 and raising rates more will likely turn a soft landing into a hard landing. The market knows this and is panicky. We would like to start adding some short exposure, but with the big looming employment report to be released before the open today, we are unsure how the market is going to react. It is unlikely to correct the fact that the market is going to correct further over the next week or so, but today's reaction could certainly skew our entry calculations making it more likely that we would stop out of a good position.

Thursday, July 06, 2006

Tech Underperforms Yet Again

Tech continues to under perform, just as it has over the last six or more months. It's early to determine if this is going to have a negative impact on the strength of the latest rally, but this is not a great way to start. The QQQQ pulled back much more harshly than the S&P 500 ETF (SPY). Now the QQQQ has met the mid point of its Bollinger bands, a point that will help mark whether sellers are serious or whether dip buyers are ready to come back in and rescue the tech sector from a retest of the low. The problem with a retest of the low would be that it would do a great deal of technical damage to the weekly chart. By our rules it is important that the QQQQ hold up at Friday's close or we may be looking at another leg lower in the market.

Wednesday, July 05, 2006

Market Overbought; Pullback Watch

The market was surprisingly strong on Monday but indices are over bought and prices are due to retrace some of the recent profits. QQQQ traders are overly bearish so this sector could maintain some support today. Nevertheless, prices at least need to trade in place for a few days to work off some of the recent overbought condition. We are looking for gold stocks to retrace most of their recent gains. A pullback in this sector should be considered a buying opportunity. Likewise, oil looks to be headed for $85 so while a pullback in sympathy with the broader market is probable, the pullback should come on lighter volume and produce a buying opportunity among the drillers as well. Today we are watching a list of oil stocks to get a better entry measurement. We would like to add oil to the portfolio, but want to see how some of the stocks perform as the traders come back from their long weekends. Keep an eye on ENG today as this will be one of our top choices.

Monday, July 03, 2006

Short Day Today

At the close on Friday program trading kicked in and a large number of stocks experienced distribution or accumulation. At this point it is difficult to determine. Technically indices are overbought and the 50-day average on the QQQQ could be problematic here as this major market indicator moved up to tag this level before selling down on Friday. This week we could see consolidation where stocks trade sideways or we could see stocks retreat and move back down to test recent lows, keeping the three-week trading range in tact. Oil and metals stocks continue to outperform and pullbacks in these sectors should be considered buying opportunities. We need to be careful with the broader market however until it proves itself. Again, program trading on Friday skewed our recent analysis and that data that we had interpreted as bullish is now in question. Today the market closes early and it will be closed tomorrow. Most traders have taken a long weekend and will not return until Wednesday. We recommend that everyone do the same. It is unlikely that anything meaningful will occur in today's market.