Option Investor
Market Wrap

Home Construction, Banks and Airlines Pace Broader Retreat

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Profit taking and a lack of short covering had the major indexes starting the week out in the red as decliners outnumbered advancers by 3:2 margin at the big board, while four and five-lettered stock symbols at the NASDAQ saw negative breadth with decliners outnumbering advancers just better than 4:3.

While both the 5-day NH/NL and 10-day NH/NL ratios improve from last Monday's wrap, it would have to be my analysis, based on observation, that the recent advance has been largely short-covering and not overly enthusiastic bullish buying.

If you were to ask me "what percentage" of each, I'd have to say that perhaps 30% of the buying we've seen the past week has been new bullish capital, while 70% has been short covering.

Take for example a much "narrower" set of NH/NL data and readings from only the S&P 500 components.

On Friday (02/01/08), the SPX/SPY had risen sharply from its 1/22/08 relative lows and Friday's NH/NL measure was 2 new highs and 1 new 52-week low for this group of 500 stocks. A daily ratio of 66.7% seems quite bullish on the surface.

However, this narrower set of internal data when compared to its 1/22/08 NH/NL measures found zero (O) new highs and 204 new lows. That day's DAILY Ratio was 0.00%, its 5-day NH/NL ratio was 3.6% and its 10-day NH/NL ratio was 10.8%.

From these types of comparisons is where I would have to visualize that indeed we've seen some "bargain hunting" bulls seeing valuations as compelling, but there's certainly been just as much, if not MORE buying from shorts/bears that have been locking in gains.

Why is this important to a trader, or an investor?

I (Jeff Bailey) feel it important as it hopes to speak to where the buying/selling is coming from, and who (bull, or bear) is doing the bulk of the buying.

So far this year (2008), the GREATEST number of new highs at the NYSE came on 1/14/08 (67:185) and the GREATEST number of new highs at the NASDAQ came on 1/02/08 (66:215) and 1/08/08 (66:444).

Closing U.S. Market Watch -

While the DJ US Home Construction Index (DJUSHB) 385.80 -6.06% lead today's list of sector losers in my U.S. Market Watch, it 20DayNet%, or 40% gain since 01/15/08 is notable. Perhaps we could envision that a surge in short covering after recent Fed action, along with some bullish buying takes a rest today.

While we don't see the same degree of percentage changes as the DJUSHB, the BIX.X, BKX.X as well as he XAL.X show up as percentage losers today, while still maintaining some 5-day (since 01/30/08 close) and rather notable gains over the past 20 calendar days.

It would certainly seem like a trader/investor has "missed the bottom" with the DJUSHB, as anyone would probably consider a 40% gain in 20 calendar days as handsome gain.

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However, history would show that with many indexes that are down 50% for the last 52-weeks, there is still some potential upside to be had. While there are some very good "reasons" to be growing some horns for the group (aggressive Fed easing being one), I don't think all of a bull's capital is going there at this point.

In last Monday's market wrap, I showed a weekly interval bar chart of the DJUSHB, and while Friday's trade was just a smidge above the Oct'07 highs of 400, I want to take a conventional retracement on the DJUSHB to the May 24, 2007 relative high and begin to "tie in" the DJUSHB as the potentially important sector I feel it may well become.

For those that have been following some of the news headlines the past year, or two, you'll know the HOUSING market and just about anything associated with the sector (Home Depot (HD) as an example) has traded weak.

DJ Home Construction Index (DJUSHB) - Daily Intervals

While the DJUSHB sees a CLOSING above its 12/31/08 close, and has seen trade above it Oct'07 relative highs, this becomes noteworthy when compared to the S&P 500 Index (SPX.X) which found its all-time high in Oct'07.

The recent trade in DJUSHB suggests profit taking from BEARS at a minimum, but a move much above the now observed 38.2% retracement taken from the 5/24/07 relative high to recent multi-year low of 245.91 could begin to suggest the group is finding favor.

So what may have triggered some of today's bias towards selling?

I think it was today's news that President Bush's $3.1 trillion budget request combined with some slowing economic trends (cooling corporate tax receipts combined with short-term economic stimulus package) had "number crunchers" showing some concern as to how things get paid for, other than the Treasury printing more dollars.

US Dollar Index (DXY) - Daily Intervals

While today's percentage decline in the U.S. Dollar Index (DXY) wasn't overly notable, some of the technicals continue to garner the attention of traders.

I (Jeff Bailey) have stated both the potential bullish and bearish outcomes of a weaker U.S. dollar. Weakness can help exporters of U.S. products as the weaker dollar against other major foreign currencies has US-made goods and services "cheaper" when compared to similar goods/services offered by countries with a strong currency than the dollar.

However, the continued decline, or WEAKNESS in the dollar is also a concern as to the currency the U.S. pays its debts with.

Recent Fed action and aggressive cutting of the fed funds target to 3.00% has found some VERY different views on Fed policy.

The aggressive cutting is to STIMULATE or flush the financial system with capital and to stimulate the economy. This monetary policy is just that. PUMPING money into the financial system to try and ease the "credit crunch," which is undoubtedly dragging on economic growth.

Treasury Secretary Paulson has been rather verbal regarding the dollar. In brief, Mr. Paulson has been saying that the dollar's strength is still in the interest of the U.S. and that its strength/weakness will likely be a major telling-point as to the world's confidence in the U.S. economy.

We should also remember that not unlike the Fed, the Treasury has also noted that budget deficits and trade deficits can have long-reaching implications if they are not controlled.

The above technicals in the U.S. Dollar Index (DXY) remain on my watch list and it doesn't take a brain surgeon to comprehend the YrNet% gains in the U.S. Market Watch for gold and silver as to why these "precious metals" are up 38.61% and 23.31% respectively.

A daily CLOSE much below DXY 74.85, its LOWEST daily close since 11/26/07 could trigger further "technical selling."

There were some other comments made today that some of the selling we've seen in equities overall in January is that some "tax sensitive" investors were, and may still be locking in gains from President Bush's temporary lowering of the capital gains taxes from several years ago.

The thought is that with Democrats now in control of the House and Senate, and this being an election year, not to mention today's budget news, has "tax sensitive" investors looking to book long-term capital gains on the premise that the "temporary" tax relief is indeed going to be just that. Temporary!

Bottom line as I see it is that the U.S. is still funding a war in Iraq, potentially offering tax credits near-term to stimulate the economy, but the $3.1 billion budget request with signs of some economic slowing would still have supply/demand analysts looking at the dollar rather cautiously.

If we believe Treasury Paulson and his view that the dollar will reflect the U.S.'s standing in the scope of the global economy, then I think we can also tie in the smaller-caps of the Russell 2000 Index ($RUT.X).

Russell 2000 Index ($RUT.X) - Daily Intervals

A review of the small caps as depicted by the RUT.X helps as look at a group of stocks that would likely be more reflective of the US economy itself. While there are some small cap stocks that derive revenue/earnings from overseas, the bulk of companies derive the bulk of revenue/earnings here at home.

As I would analyze the market internals and NH/NL indications as showing greater buying from short covering, perhaps we can see how the recent CLOSE above 688.59 served as support, where the NEXT LEVEL HIGHER became a BEAR's risk assessment and a BULL's target to take some profits.

A 38.2% retracement of a range (10/11/07 high to recent lows) currently suggests a normal corrective bounce.

A close BACK BELOW 688 would be deemed a NEGATIVE.

Pacholder High Yield (PHF) - Daily Intervals

I've said before that it would be painting the small caps like the RUT.X with a broad brush to say that their debt (bonds a small cap company has issued) would be "junk bond" rated, but a small cap may be viewed as "riskier" than a mega-large cap like a Dow Industrials component.

While many small caps kick off little dividend, the primary reason a trader/investor will put money to work in the group is that a smaller company can GROW faster than a BIG company.

What the "junk bond" PHF does is actually give us a look, or observation of the RISKIEST bonds (junk bonds are RISKIER than high-grade corporate debt).

It is somewhat encouraging to see the PHF nearing its 50% retracement (10/15/07 relative high to recent 01/22/08 low).

Using the PHF only as an observation of a "junk bond" related security, if you, or I had purchased 100 shares at $9.23 on 10/15/07, we would have received $0.225/share in dividend. A "cost basis" of $9.23 would be about $9.005/share.

When you look at the U.S. Market Watch above, you can see they YrNet% of PHF is down 18.46%, while the RUT.X is down 10.61%.

If we "rolled out" an entire year's worth of dividends for the PHF as $0.075 ($0.90/share) we would see that all-things being equal, small caps and PHF a "junk bond" security would be roughly EQUIVALENT RISK at this point.

I say that as PHF trades $8.29 at tonight's close. Should it continue to pay a $0.075/dividend per month, or $0.90 for the next 12 months, its SEC Yield could be 10.8%.

On a YrNet% comparison, the RUT.X is down 10.61% and the PHF is down 18.46%, which is a difference of 7.85%.

What the "junk bond" PHF begins to tell us is that there is SOME sign of credit market healing.

From a perspective of RISK, a company's DEBT is SAFER than a company's STOCK. At least DEBT holders (bond holders) could recoup some cash if a company goes BANKRUPT.

It is encouraging to see "junk bonds" showing some sign from the MARKET that DEBT is deemed less risky that "small caps."

S&P Depository Receipts (SPY) - Daily Intervals

Using retracement anchor points on the more "multi-national" S&P 500 Depository Receipts (SPY), it looks VERY similar in a range of retracement (10/11/07 high to 01/22/08 low) as the small caps.

It is for THIS very reason that we need to be ALERT to the dollar's weakness.

Remember, one of the BULLISH dynamics that has been found from the WEAKER dollar is the "US goods cheaper."

IF that is the case going forward and we see FURTHER weakness in the dollar, then the comparison charts shown above for the RUT.X and SPY should NOT be looking the same.

If the dollar continues to weaken and the RUT.X and SPY head south together, then that has to suggest to this analyst that the MARKET is VERY concerned about the dollar weakening, the budget deficit and the possibility of "temporary tax relief" ending.

When temporary "tax relief" ends, that equates to a "tax hike."

That's not necessarily a "good thing" if the ECONOMY is SLOWING.
 

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