Securities Research Services

Wednesday, January 31, 2007

Industrials are the Place to be

Volatility has been almost non existent over the last few days as no one is willing to make a bet in front of this week's Fed minutes. Rumors about rate hikes are back, but we believe there is almost no possibility. Bonds, which have been falling have been essentially raising rates little, by little every day for a while now. The Fed is certainly not going to exacerbate the situation.

We are entering the end of the month window and stocks have been holding up well, which is bullish. The IWM continues to trade near highs, but we wouldn't bet on a breakout there just yet.

Meanwhile, money continues to flow into the industrials indicating that we may be on the verge of a reacceleration of capital spending. Growing economies mean growing markets, so the outlook continues to improve here.

Tuesday, January 30, 2007

Dull Days in Front of Fed

The IWM (Russell 2000) continued to show strength yesterday. However, it closed up against resistance so it may move back to support from here. The rest of the market remains range bound and with the Fed meeting over the next two days, this situation is probably not going to change today.

Scans today turned up a rather innocuous picture where most stocks show that they will continue to drift as the market consolidates. A few stocks popped up on earnings, but most of these moves are not tradable.

In the market there are days where it pays to get aggressive and there are days were it pays to just not do anything. Today is one of those days where it pays to just not do anything. Gamblers need to keep on rolling the dice, but good traders know when it's time to wait for higher probabilities.

Monday, January 29, 2007

Small Caps Finding More Strength

The trading range we highlighted on Friday morning did indeed assert itself and a quick dip below $43.50 on the QQQQ found buyers. Once again, it does us no good to over think the daily moves in this market. It is range bound here and panicking on support tests and getting excited as prices move off support are both irrational emotions that represent a reaction to meaningless data.

Just keep the big picture in mind. The longer term bull trend is in tact and a breakout to the upside is almost a given in coming weeks. Those putting on shorts in hope that the market will break down here are probably due for some serious pain.

We did have a couple of interesting developments last week. While the blue chips and even big cap tech were under pressure late last week, the semiconductor sector, SMH, was actually trading in positive territory. The SMH is of course still range bound, but the fact that sellers are no where to be found, even on weak days, and that buyers continue to buy at support are both positives here.

The other interesting development is the fact that while the broad market indices such as the Dow, S&P 500 and NASDAQ, all have another week or two before they will run into their longer term up trends, the Russell 2000 small caps, represented below by the IWM, has been finding support at its long term uptrend and is projecting an upside breakout this week.

Friday, January 26, 2007

Trading Range Asserts Itself

Thursday's market really gave bulls a scare and has everyone talking about a potential market collapse again. We think that there is no reason to over think this market so much.

Let's put things into perspective.

The QQQQ, as seen above, has been ranging between $43.50 and $44.75 since November 15. It took one dip to its 50-day average in late December and tried to break out in early January, but the trading range held both moves in check and the market returned to its mean.

In other words, this has been a non trending market; a market trading sideways. Understanding this fact, we don't see any reason to interpret Thursday's move as either bullish or bearish as it was more just a reflection of the choppy nature of the current market.

If you look over at the bottom right of the chart, however, you will note that there is an upward sloping trend line. This line represents the up trend which started way back in July. The fact that the QQQQ has been trading in a tight trading range over the past nine weeks is a reasonably bullish development.

Look for the QQQQ to remain in this trading range for a few more weeks. There is some potential for prices to drop slightly below the range here, but that would take the QQQQ back to trend support where it should bounce. A drop to the trend here would be less bullish than a continued sideways move though. A drop to support here would cause some ugly divergences to develop on technical indicators and would call into question the ability to hold the trend. If the market can maintain this range, we should see significantly higher prices in coming months.

Thursday, January 25, 2007

Rotation Into Metals

Tech found footing yesterday, but we suspect that this rally is not going to get far. It would be tough to short tech here, but we don't recommend trusting the strength beyond just a few day's trading.

Meanwhile, money that was flowing strongly into tech over the last month now appears to be making its way into the manufacturing and metals sectors. Steel broke out with volume over the past two days and golds are moving up nicely as well.

Wednesday, January 24, 2007

Wary of the Tech Bounce

Buyers took advantage of shorts who were leaning too hard yesterday. This created a turn around Tuesday, which has been quite common lately.

Even so, tech continues to lag so we will be looking at its bounce for an opportunity to short some of its weaker components. The QQQQ could be carving out a head and shoulders top here, so this is something to think about as prices rally.

Tuesday, January 23, 2007

In Between a Rock and a Hard Place

Sellers remained heavily in control of the market yesterday. The Semiconductors are at important support levels and the broad tech sector, as measured by the QQQQ has pulled back to its 50-day average. As such, there remains a chance that stocks will hold today. However, if sellers keep on hammering at support levels, we may see prices continue to bleed lower for a week or two.

We had hoped that bulls would have remained optimistic enough to try and rally the market back up again this week. That would have created a nice short set up. The fact that selling has remained relentless so far makes for tough going.

Very aggressive traders have a trade if the short some of the weaker tech stocks here, but in doing so they take on an additional risk of shorting against an already oversold market.

We strongly advise focusing on preserving your trading account by tightening trailing stops and not opening any new trades until better set ups emerge. Long side set ups are in jeopardy of failure here, so it's not a good idea to buy weakness in this market. And, as we already stated, oversold bounces put new shorts in jeopardy as well.

On Tuesday we find ourselves in that middle ground market where risk is very high on both the long and the short sides. When the going gets this tough, the tough may get going, but the smart ones move to the sidelines and wait for better times.

Monday, January 22, 2007

Small Bounce Expected This Week

The QQQQ experienced a breakout failure last week. Nevertheless, prices are likely going to disappoint shorts and refuse to follow through lower; at least for now. Friday saw decent buying support and we would expect to see prices bounce back higher this week.

Many tech stocks saw serious damage though, so we will carefully consider shorting any strength this week instead of getting aggressive on the long side again.

Friday, January 19, 2007

Tech Takes One on the Chin

The week promised to be uneventful and when the market promises something, it oftentimes does just the opposite. The market is an unreliable friend.

Tech took a heavy hit yesterday as the QQQQ sold off on heavy volume causing a failure to occur on its recent much ballyhooed (by us anyway) breakout. We had been complaining over the past two days that good set ups were just not to be found. This should have been enough warning considering the fact that in the past when scans didn't turn up good trades it has been a precursor to poor market performance.

Dip buyers may step in and offer support here and the larger trend remains up. Even so, it pays to be careful here and any further rallies are definitely opportunities to sell and not signals to buy.

Thursday, January 18, 2007

Options Week Games Continue

Games were indeed played yesterday as stops on many stocks where gunned in the afternoon, only to see prices recover again late in the day. We count all this activity as market noise in front of tomorrow's options expiration.

What this "market noise" has done, however, is make it very difficult to find a good stock set up. Oil prices look like they may attempt a bounce this week, but that too may just be options expiration activity, which is not going to have a lasting impact into next week. Due to the sharp fall in oil, there has been a fairly heavy short position taken in the sector. Options writers would love nothing more than to see a sharp one or two day climb in the oils that would erode profits on open put contracts.

We are doubtful that oil can mount a meaningful longer term comeback from here, so the probable dips in the breakout transport sector may be buying opportunities.

We await to see if the pullback in tech finds buyers. We suspect it will.

Wednesday, January 17, 2007

Options Week Keeps a Lid on Market

Options expiration is this Friday and the normal pattern going into expiration Friday is a trading range to kill time premium on options and allow option market makers to buy back cheap options (and allow the worthless ones to expire). Thus, it should be a quiet week in the stock market.

Monday, January 15, 2007

Tech Set Up Interesting Here

The week closed strong last week but now the market, and in particular, the tech sector, is overbought. Of course overbought conditions can remain for quite some time in a strong bull market, so it doesn't necessarily mean we have to pull back here. Even so, take a look at where the QQQQ is at on its weekly chart.
As you can see, it has channel resistance at $46. This channel has repelled the QQQQ three times in the last four years. There are good reasons to believe that this time will be different, but we need to be wary of this $45.50-$46.00 area and give it respect.

As we said, there are some good reasons to think that this time might be different. The bearish case is obvious (resistance and overbought market conditions), so we will focus primarily on the bullish case here.

1. The QQQQ is trading in a "bump-and-run" pattern after it fooled traders on a false breakdown last July. This dip below support is a classic shake out pattern that often occurs before major bull markets begin.
2. The QQQQ seems to be carving out a cup and handle pattern. This is also a technically bullish development.
3. Major QQQQ components are very strong: MSFT broke out above a similar channel a couple of months ago and is now on a tear as institutional money floods in. Likewise, unless you have been on vacation in Siberia, you know that Apple (AAPL) has been breaking out as the market excitedly embraces the iPhone.

Money has been moving out of energy and into tech for over a week now and the movement has been quite dramatic. This is setting up to be the year of the tech. Could it be a fake out? Yes, definitely. We need to be wary of that and until the QQQQ breaks through resistance we need to be extra careful. So far it looks really good for the techies though.

Friday, January 12, 2007

There Remains Money to be Made in this Hot Market

Tech continues to rally as the QQQQ broke outside its upper Bollinger band. The QQQQ has major resistance at $46 and is likely to get there before this rally is over. In the meantime though, the extreme move represented by the move above the upper Bollinger may cause pause in the sector for a few days giving the other indices time to catch up.

At least that is the healthy expectation.

Tech could continue to rally higher, but then stocks would be on much shakier ground and a larger correction may loom. But let's worry about that when and if it becomes an issue. Right now there is still profit to be made from this rally and focusing on a potential future correction will keep you from profiting now when the market is hot.

Thursday, January 11, 2007

Small Caps Ready to Join the Tech Rally

Last week we outlined our reasons why the small cap sector was gearing up to lead the market higher after underperforming the blue chips during the entire fall rally. The IWM (Russell 2000 ETF) then proceeded to break down instead of higher seemingly nullifying our prediction.

That was last week. This week the IWM has caused eager shorts a great deal of pain as it has refused to follow through lower. Instead, the breakdown has reversed and can now be considered a failure as can be seen below.

But what happens when a stock or an index rallies back up after a breakdown fails? We need look no further than the current market leader QQQQ to see. Note the failed breakdown in late December in the QQQQ chart below. Now the QQQQ is powering higher and is threatening to break out to multi year highs. Look for a similar development in the IWM to ensue.

What happens if the IWM starts to move? We should start to see some nice fast moves in some of the lower priced stocks. This is something we have yet to see in this rally, but it looks promising.

Wednesday, January 10, 2007

Sentiment Readings Might Mean this Time is Different

Yesterday's trading was choppy as the market tried to digest the meaning of continuing weak oil and other commodity prices. Falling commodities seem to be projecting an economic slowdown, which is causing some concern before earnings season, which kicks off next week.

Sentiment readings swung into the extraordinarily bullish direction yesterday as an extreme 14-1 QQQQ calls were purchased against puts. As long time readers know, an extreme reading of 2-1 calls to puts is considered overly bullish and tends to proceed a market correction. Readers may also recall, however, that we witnessed similar extraordinary extremes in October right before the market powered higher.

The lesson here is that while overly bullish sentiment is not healthy for continued price highs, an extreme number like yesterday's seems to represent a level of confidence from a group that knows something. So, while we are need to remain cautious here and keep our fingers on the trigger ready to exit if something goes wrong, it looks as if a group of institutional traders is making a similar bullish bet as the one made in October, which paid off handsomely.

Tuesday, January 09, 2007

S&P 500 Resumes Uptrend

As predicted yesterday, the SPY found support at its 50-day average and turned higher again. This is a bullish development, which should keep stocks trading positive over the rest of the month.

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Monday, January 08, 2007

Tech Sector Points Higher

Rally disbelievers were screaming distribution on Friday as the S&P pulled back, but should we worry? Let's check the facts.

The QQQQ rallied last week and money flow on the index broke out confirming a rotation into this sector. In the past, the broad market has always followed higher a few days after the QQQQ has led the way. This time may be different, but it probably won't be.

Likewise, let's put Friday's S&P pullback into perspective. As you can see below, the SPY is merely pulling down to its rising 50-day average. If it touches down on this average this week, it will be the first time it has done so since it broke above on August 15. This has been a strong trend and strong trends find defense at their 50-day average as the pullback crowd eagerly awaits a high probability buy. Also note that the SPY broke out above its weekly resistance line in November. This line now provides a high degree of support.

Friday, January 05, 2007

Rotation Into Tech Gives Bulls the Edge

This week has been all about rotation. We had to take a conservative approach and stay sidelined most of this week as energy stocks, which were highly profitable for us over the past two months, went into a melt down. Staying mostly sidelined over the past two days has paid off though. While the trading picture was still murky yesterday, it is now clear that money from energy stocks is now being rotated into tech. Bull markets don't generally go very far without tech leading the way. The QQQQ (Nasdaq 100) has been lagging this bull market since spring. But now something interesting is taking place. The QQQQ bounced off its 50-day average this week and yesterday blasted higher on heavy volume. This is a very healthy bull market development.

Thursday, January 04, 2007

Watch the Small Caps

After breaking out late last year the Russell 2000 (represented below by IWM) has been trading in a contracting triangle pattern. Contraction after a breakout and improving money flow in the sector project that small caps are gearing up for an important break higher. So far during this rally, blue chips have been the market leaders. If the IWM does indeed break higher here, the baton will be passed along to the small caps, creating new opportunities in some of the faster moving, higher beta stocks.
The new year started off with a wild ride as stocks first made high volume gains on program trading, only to reverse and go negative before closing virtually unchanged. The swings were hard on stop losses, but did virtually nothing to the trend. If indeed we are correct about the small caps, then yesterday's low should be the ultimate near term low and stocks will now be free to continue higher.

Wednesday, January 03, 2007

Wait and See Mode Today

Friday's trading was non committal, which was to be expected. Not only was the market closed for a very unusual 4-day weekend, but today professional money managers return from their extended vacations. Factoring these two items into the equation is not enough though. Topping off the uncertainties we face today is the fact that we start a fresh new tax season today.

Because of these uncertainties we have neutral charts pretty much across the board. It is important to stay open-minded about the immediate outlook this week. The fact is, we just don't know if the pros are going to come back today in a selling mood or if they are ready to buy. Friday's options reading was overly bearish. Moreover, the first week or two in January is generally positive. As such, we may see buying today, but evidence for either the bullish or bearish case here is pretty subjective.

If you are itchy to dive into the market after the long weekend, try to restrain that itch and take a sideline seat today. Uncertainty is not a good environment to open new trades into. The year is just beginning and there will be plenty of chances to put money to work. For today, wait and see what sets up after the long weekend. If you do, you will have a better chance of putting the probabilities in your favor.