Securities Research Services

Wednesday, May 23, 2007

Sector Rotation May be Underway

The Dow and S&P gave sell signals again yesterday. However, we are highly suspicious that these signals are bear traps. There are a number of technical and fundamental factors favoring a bullish posture in the near term.

First, sentiment is extreme here. Options traders are favoring nearly 3 puts to every 1 call contract. This bearish sentiment is a strong and reliable indicator that prices will move higher. Second, the QQQQ broke out on Monday and then yesterday it spent the day consolidating gains in what will probably result in more upside over coming days.

The market remains afloat in a sea of liquidity. Yen carry trades are likely the main source of liquidity. And right now there is little economic data for traders to take a cue from, so with cash in their coffers they continue to buy.

Finally, we are very near the end of the month buying window when the market is generally positive.

Weakness in the S&P and Dow over the past few days may have more to do with sector rotation than distribution (which is how we had interpreted it as late as yesterday). As such, we are adjusting our posture from bearish to cautiously bullish. Keep in mind that the market is dynamic and it requires a daily reassessment of the data and flexibility. Being married to one opinion can be damaging to one’s portfolio.

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