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If 524 doesn't hold, the markets could fold

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Late last year I felt the deep cyclicals were the key group of stocks for bullish traders to be looking for leadership longer- term. The next several sessions could be critical for how the U.S. stock markets play out longer-term. It was my belief late last year that technology stocks were "nowheresville" without good numbers and earnings from the deep cyclicals. The deep cyclicals would only advance higher with the signs of a strong economy. Should the Morgan Stanley Cyclical Index (CYC.X) break the 524 level or thereabout, then things could get worse than they are for technology stocks and the broader market averages.

Morgan Stanley Cyclical Index (CYC.X) - last 11 months

Traders that believed the deeper cyclicals were the "safest" way to play the economic recovery late last year based on their belief that this group of stocks would lead in such a recovery phase, need to keep an eye on things here. Should we see a break much below the 524 level, we'd witness a breaking of three fairly major levels of support.

One reason I've been mentioning shares of Minnesota Mining and Manufacturing (NYSE:MMM) as a good short candidate is that it looked to be an ideal stock to be shorting, not only technically, but as a strategic trade against the cyclicals. Should the CYC.X violate the 524 level on a significant basis and retreat to the lows of 480, I don't expect good things to be taking place in shares of "3M" (MMM). In today's "hot list" on OptionInvestor.com we felt the rally in 3M at the $106 level was another opportunity to get short. The stock edged higher to $107.62 then got hit hard to the $104 level. There are still some good shorts to be found.

Bears should NOT be complacent. The 30-year YIELD ($TYX.X) has been hanging around the pivot point of YIELD we have identified where we've seen sharp moves higher in the past. Current YIELD on this bond is 5.366% and we haven't seen a rush of buying come into this bond today. The 10-year YIELD and 5-year YIELD are also holding near yesterday's close. One item that may be accounting for some of this activity is currencies. The U.S. Dollar is weak against the major foreign currencies today and trader talk has it that some money is flowing from U.S. markets (bond and stock markets) due to the recent European Central Bank rate cut.

Software and Networking stocks continue to be the weaker sectors and I would continue to try and avoid many of the names in this group. I've identified one Networking stock in recent sessions that looks like a champ compared to the group in general. Under current market conditions, shares of SpectraLink (NASDAQ:SLNK) continue to trade strong, but broader market and sector activity is keeping the stock in check. Should we get a broader panic sell in the markets, I'd be more bullish on the stock between the $12 and $14 levels. Shares of SLNK currently are trading near the $16.87 level.

Jeff Bailey
Senior Market Technician

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