The Theory And Its Application
The S&P 500 (SPX.X) continues to out perform the Nasdaq, relatively speaking. If that much holds true, "easier" profits may be found in the SPX over the short- and intermediate-terms. Of course, when I say "easier" profits, I'm referring to moves of the advancing nature.
Wednesday's price action across the broad market averages reinforced the fact that the S&P 500 is leading. For the day, the SPX finished 1.60 percent higher, while the Nasdaq-100 finished 1.42 percent higher. Meanwhile, the Nasdaq Composite (COMPX) finished with a 1.25 percent gain, while the Dow Jones Industrial Average finished 1.59 percent higher.
The following chart depicts the relative strength of the S&P 500 versus the Nasdaq-100. (I like to compare and contrast the SPX versus the NDX because those two cash indexes are also liquid futures contracts.) By employing simple direction analysis on the chart, we can determine that the SPX's out performance since early June is accelerating. Therefore, can we conclude: SPX = Profits * Relative Strength^2? Alright, that's stretching it; the point is, the path of least resistance to the upside is in the S&P 500.
Because the SPX is out performing the NDX, that probably means the Nasdaq market is oversold, relatively speaking. The bullish percent figures for the two indicate that much. Through Tuesday's session, about 52 percent of the S&P 500's components were on sell signals, while 75 percent of the Nasdaq-100's components were on sell signals. Furthermore, daily stochastic readings for the NDX are more oversold than those for the SPX. Therefore, a short-term, strong market advance would probably allow for the NDX to outpace the SPX, due to the former's oversold condition. We must take into account, however, that the NDX is a higher beta index, thus greater risk. So we arrive at a question of preferences. Which is better, higher probabilities with less risk, or greater risk with potentially greater profits? The answer to that question depends upon individual preferences, and should dictate which index is the "better" to trade.
To digress from my theorizing, there are three observations I'd like to point out concerning the price action of the S&P 500. The first is that the SPX bounced from its aggressive, ascending support line Tuesday around the 1165 level. That bounce marked the third observation, with the other two traced in late March and early April. Second, the SPX CLOSED on its 61.8 percent retracement level Tuesday at 1170. Although it dipped below that level Tuesday, its settlement around 1170 was more important. The third observation I'd like to make is of the voodoo black magic variety, and brought to my attention by Jeff Bailey. But it's compelling enough to write about, so bare with me.
The SPX traced its year low at 1081 on March 22. Exactly nine days later, it bounced from 1091 before going on to stage an advance of historic proportions. Here's where it gets interesting. The SPX traced a relative low at 1168 on July 11. Exactly nine days later (Tuesday), it bounced from 1165. I'll let readers draw their own conclusions.
The National Association of Realtors reported Wednesday that previously owned single family home sales fell by 0.6 percent during June, which was a smaller drop than expected. The housing market remains one of the strongest in the U.S. economy, as Greenspan reminded the Senate Tuesday. And one sector of the stock market that may be benefiting from the healthy housing business is the Forest & Paper Products Index (FPP.X). In fact, the FPP has been trading relatively strong versus the S&P 500, which may, in part, stem from the strong housing market. Components of the FPP that are especially leveraged to the housing market include Weyerhauser (NYSE:WY), Temple Inland (NYSE:TIN), Boise Cascade (NYSE:BCC), Georgia Pacific (NYSE:GP) and International Paper (NYSE:IP). It's worth noting, however, that any spike in energy prices does not serve this group of stocks well.
But the natural gas stocks would most certainly be well served by a spike in energy prices. The Natural Gas Index (XNG.X), in contrast to the Forest & Paper Products Index, has traded extremely poorly relative to the S&P 500 recently. But OPEC's actions Wednesday could reverse that trend over the short-term. Oil Producing & Exporting Countries' (OPEC) ministers agreed Wednesday to cut production by 4 percent in an attempt to lift sagging crude prices. As a result, crude futures (CL01U) rose to $26.80 per barrel Wednesday - their highest level in two weeks. In addition, the American Gas Association (AGA) reported midday that inventories recently rose less than expected. (It's all about supply and demand, baby!) Following the AGA report, with the momentum of OPEC's actions, the Natural Gas Index and its components skyrocketed to a 5 percent gain for the day, far outpacing the broader market averages. This group of stocks and indeed the broader energy sector is deeply oversold, more so than the Nasdaq-100. As such, a sustainable advance is possible if crude prices continue working higher. Stocks in the Natural Gas Index worth investigating include Anadarko Petroleum (NYSE:APC), Burlington Resources (NYSE:BR), EOG Resources (NYSE:EOG), El Paso (NYSE:EPG) and Noble Affiliates (NYSE:NBL). There may be a compelling trade setting up in the XNG relative to the FPP if energy prices continue higher.
One earnings report in the after hours session that may perpetuate the momentum in the Natural Gas Index was that from Haliburton (NYSE:HAL). The world's largest oil service company and former child of Vice President Dick Cheney reported earnings that beat estimates by 3 cents per share. Shares rose by a little more than $1 in after hours. Like the XNG and its components, shares of Haliburton have performed extremely poorly recently. (Haliburton is a component of the Oil Service Index (OSX.X).)
In other after hours earnings news, Homestore.com (NASDAQ:HOMS), which is a rather unique dot com, reported earnings of 13 cents per share. Its numbers handily beat estimates, which had the company pegged to earn 11 cents per share. What's even better is that Homestore projected full year earnings of 55 cents per share, while previous estimates had called for 53 cents for the year. Yes, Homestore raised guidance. It makes sense business should be good for Homestore because it is, after all, a real estate company. Its earnings report was well received in the after hours session as shares rose roughly $3.
Elsewhere, the reports from the tech sector were mixed, with a slightly negative tone. Compaq Computer (NYSE:CPQ) matched estimates for its second quarter, but guided lower for its fiscal third quarter. Analysts had been expecting Compaq to earn revenue around the $9.3 billion mark during its next quarter, but officials from the box maker guided expectations lower to between $8 and $8.4 billion. That's obviously a significant revision lower and is a testament to the ongoing price wars between PC makers. Judging by the recent price action in the box makers, Dell (NASDAQ:DELL) is winning the war in a big way over Compaq and Gateway (NYSE:GTW).
The optical cable maker Corning (NYSE:GLW) reported quarterly earnings that were slightly better than what estimates had been predicting. But get this: During the same quarter in 2000, Corning reported a profit of 17 cents per share; it reported a loss of $5.13 this quarter. Granted, the company took a $4.8 billion charge this quarter, but it's still very ugly. Corning officials recently decided to NOT give guidance, so no financial targets were given during the conference call. But one official was quoted as saying that the telecom business remains "turbulent." Nevertheless, shares of Corning rose modestly in the after hours session.
Wednesday's earnings reports may serve as a microcosm for the market. Homestore.com, a company highly leveraged to the U.S. consumer and housing market, reported numbers that were pretty darn good on the surface. And the same goes for Haliburton - officials issued guidance that was most bullish during the conference call. But the comments from the likes of Compaq and Corning reflected how difficult of a place tech remains, whether you're trading or investing in that sector. Officials from Corning used words such as "turbulent." And Compaq's CEO said, "It's an understatement to say that we're in the midst of an extremely challenging global market." So which group of stocks are probably "easier" to trade? I may not have the answer to that question, but I do not which group of stocks is the most "difficult" to trade: Technology.
Sure, by foregoing tech you're missing the opportunity of short, sharp, large rallies, which was the premise behind my Market Wrap Monday. But with that comes added risk. So it comes down to one question: Relatively speaking, is the risk worth the potential reward? (The operative word is potential.)
"When you sit with a nice girl for two hours, it seems like two minutes. When you sit on a hot stove for two minutes, it seems like two hours. That's relativity."
- Albert Einstein