Craving A Catalyst
Following the big short covering rally Wednesday afternoon, the expectation going into Thursday's session was for higher prices in the broader market averages. However, in typical fashion, the averages popped just enough this morning to lead market participants astray before drifting lower due to a lack of a catalyst. The choppy, drifty action is making this tape a difficult one to game. Having said that, I reinforce that traders - both longs and shorts - need to practice nothing but discipline in the current market landscape. When translated, discipline means having sound risk management in place (read: stops).
With no real catalysts to neither buy stocks nor sell stocks, the best game in town continues to be the fast and furious sector rotations that I, along with Matt Russ, have been mentioning recently. But even the sector rotation game was tough to discern during Thursday's trading. Of the 20, or so, sectors I follow each day, only three finished with gains. And of those three, two sectors finished only marginally higher. As you'll see on the sector watch list below, the three advancing groups were the Oil Index, Pharmaceutical Index and the Health Care Index. Worth noting, all three sectors are defensive in nature.
Here's a quick list of some of the leading stocks within each sector.
CBOE Oil Index (OIX.X): Exxon Mobil (NYSE:XOM), Chevron (NYSE:CHV), Texaco (NYSE:TX) and BP Amoco (NYSE:BP). There are obviously more components to the Oil Index, but these stocks are some of the bellwethers that are worth monitoring.
AMEX Pharmaceutical Index (DRG.X): Merck (NYSE:MRK), Pfizer (NYSE:PFE), Eli Lilly (NYSE:LLY), American Home Products (NYSE:AHP), Alza (NSYE:AZA), Watson Pharmaceuticals (NYSE:WPI), Abbott Laboratories (NYSE:ABT) and Schering Plough (NYSE:SGP). Again, there are many stocks to watch within this group, but this list should serve as a good reference.
S&P Health Care Index (HCX.X): Cardinal Health (NYSE:CAH), PacifiCare Healthy Systems (NASDAQ:PHSY), Healthsouth (NYSE:HRC), Humana (NYSE:HUM), Oxford Health Plans (NASDAQ:OXHP). The S&P Health Care Index has many sub-sectors within it, but the aforementioned names should serve as a good representation of the broader group.
To reiterate, the three aforementioned sectors are defensive in nature and should capital flow back into the growth sectors of the market such as tech and finance, the defensive groups of stocks are likely to pullback. Nevertheless, the three sectors and some of the stocks within those groups should serve as a good reference in attempting to game the direction of the broader market going forward. What's more, the three defensive sectors I reviewed can offset some of the systematic risk associated with tech and finance; energy, drug, and health care stocks can act as hedges. But to make it perfectly clear, if tech and finance find some bids Friday, these three sectors are likely to decline.
Now let us segue from defensive to offensive sectors. The Semiconductor Sector (SOX.X) has problems, big problems. As I mentioned earlier this week, I feel that the SOX is crucial in the progress of the Nasdaq Composite (COMPX). And unfortunately, as I had speculated on Monday, the weakness in the SOX is spilling over into the COMPX. I mentioned last Monday that, in my opinion, it was crucial for the SOX to hold above its 50-dma, which it did Tuesday and again Wednesday. However, the SOX, for the first time in a month, settled below its 50-dma. Keep an eye on shares of Intel (NASDAQ:INTC) and Applied Materials (NASDAQ:AMAT) to game the blue chip portion of the SOX. For the more aggressive portions of the chip sector, I like to watch shares of Xilinx (NASDAQ:XLNX), only because I trade the stock often and know its behavior in relation to the SOX.
Along with the SOX and its impact on the Nasdaq Composite, I feel that shares of Cisco Systems (NASDAQ:CSCO) are equally important. The $30 level in shares of Cisco has acted as a floor for the stock following the company's earnings miss on Tuesday. If the $30 level breaks, and shares of Cisco begin to drift lower into the $20s, I think the COMPX will probably see the 2500 level in short order. Conversely, if the shorts begin to bring in their positions in Cisco, and the stock subsequently lifts from the $30 level, the COMPX may find a bit of relief and drift higher. But without a catalyst to cover shorts and buy Cisco, it's tough to say definitively which direction the stock will trade in. I'm not attempting to game Cisco here. Rather, the stock should be another variable to monitor when planning trades in the tech sector.
One positive that I took away from the action in the COMPX Thursday was at least it didn't take out its day low from Wednesday, which was put in at 2554. If the rotation back into tech stocks begins early Friday morning, traders might attempt to pick a bottom near 2554, because the risk in doing so is pretty easy to quantify - a mental stop could be set just beneath the 2550 level in the COMPX. If the COMPX drifts below the 2550 level, it could very well make its way to 2500 as I don't personally see much support below 2550. The way to discern rotation back into tech stocks is to monitor price action in the SOX, shares of Cisco, and the defensive groups I alluded to above. These, of course, are just the variables that I follow, but should serve the purpose of monitoring rotations. The individual risk tolerances and time frames of traders should dictate the individual metrics they follow.
By scaling into some tech exposure near the oversold levels in the COMPX, traders can position for a potentially high-rewarding bounce while containing risk to relatively small increments. However, this is a strategy that only active traders should pursue, who have the ability to monitor positions throughout the day. For those traders unable to actively monitor positions and manage risk, I wish I had a strategy for you to employ in the current marketplace. The fact of the matter is that I don't feel comfortable suggesting any sectors or stocks for intermediate-term trades - that is, trades that last longer than a day or two. However, as soon as I discern a trade that has the possibility of a prolonged move, I'll be sure to convey that message in my market commentary.
Two trades that had been working for a prolonged period of time recently were in the finance and retail sectors. However, those money-making trades have come to an abrupt halt this week. Thursday morning, several retailers warned of lower profits and weak same-store sales in the month of January. Among the notable warnings, Gap (NYSE:GPS) said same-store sales were in the red across all of its divisions, which includes Gap Stores, Old Navy and Banana Republic - by the way, Banana Republic is a much-visited store by this consumer. I do my part in boosting Gap's sales in that division.
The retail sector has run-up over the last several months in anticipation of lower interest rates. And up until this morning's warnings, the retail sector was still running as measured by the S&P Retail Index (RLX.X). The same-stores sales reports this morning gave traders a reason to take profits in the group, and I suspect that the sector will now settle into a consolidating trading range. However, with more interest cuts looming in the not-too-distant future, I think the retail sector has room to trade higher. The name of the game right now with the retail sector is to wait for the leading stocks in that group to base for a decent amount of time, and look for entry points during their next legs higher. Some stocks that have been acting well within the group include: Steve Madden (NASDAQ:SHOO), Christopher & Banks (NASDAQ:CHBS), American Eagle Outfitters (AEOS), Abercrombie & Fitch (NYSE:ANF), Costco (NASDAQ:COST) and Liz Claiborne (NYSE:LIZ). Here again, the list could go on, but these names are a good starting place. And to reiterate with the retailers, I would expect some consolidation so be patient with the group - but that's just my opinion. As always, refer to price action and not my opinions.
The finance sector, like the retailers, is also pulling back on profit taking. There isn't a real good reason to sell the financials right now, other than to take profits. The financial stocks will trade higher this year as the preceding interest rate cuts work their way through the economy and the upcoming interest rates cuts get discounted into share prices. I think there will be a lot of upside surprises in earnings in the financial space in the coming six months, and for that reason the group still looks attractive to me for investment purposes. Keep in mind that there's a big difference between trading and investing! For trading purposes, I think it's difficult to game the short side in the financials. Although OptionInvestor is gaming the profit taking in a Goldman Sachs (NYSE:GS) put right now, I think any short in the financials should be approached with tight stops. The Fed is on the offensive, it's just that simple. In trading the long side in the financials, at this point, it's a question of when the profit taking subsides and the base-building begins. Once these stocks in the financial space build a base, look for breakouts, or even consider gaming bottoms. For a good case study on how to game profit taking, consolidation, and subsequent breakouts in the financial space, take a look at shares of Astoria Financial (NASDAQ:ASFC). This isn't a recommendation to buy the stock. Rather, a study on how to trade finance stocks.
And with the finance stocks pulling back on profit taking, the Dow Jones Industrial Average (INDU) will have a hard time breaking the 11,000. I know the INDU has poked above that level this week, but has not closed above that level yet, which is key in my mind. Matt Russ called it pretty closely in his market commentary Wednesday when he suggested the INDU would pullback to 10,850 if it didn't plow above 11,000. The 10,850 level looks like solid support, but if it fails, a decline back down to 10,800 is likely. That might be the spot to leg into some financial exposure as the risk is pretty easy to quantify. And although I've suggested ways to pick the bottom on both the INDU and COMPX tonight, you must keep in mind that picking the bottom in any market operation is a difficult proposition. Realize that no trader can pick the exact bottom in any market consistently. However, a trader can attempt to pick the bottom by slowly scaling into exposure at clearly defined levels, after clearly defining risk parameters.
I'd like to make it clear that the market is very difficult to game right now. I would suggest trying to game the sector rotations which have been so dominant this year. But, in doing so, it's crucial to know the levels of support and resistance in the sectors you're trading along with the individual mediums with which you plan on trading with. With the oversold condition of the tech sector, I would expect a relief rally beginning as soon as tomorrow morning. But I was of the belief that the Nasdaq would advance today, so it goes to show that my opinions, in the end, mean nothing to the market. Until a clear catalyst emerges to buy stocks, trading will be tough and choppy. We'll make sure to cover some potential catalysts in this weekend's market commentary.
Also, I'd like to thank the hundreds of people who took the time and effort to send in their opinions and suggestions concerning my market commentary. I'm in the process of replying to each and every reader who was motivated enough to respond. If you haven't received a response from me, it's on the way.