They Ain’t Dead Yet

10/20/2008 1:47 pm EST

Focus: ETFS

Jim Farrish

Founder and CIO, Jim's Notes

Jim Farrish, editor of SectorExchange.com, finds some ETFs that have bounced back nicely from their lows a couple of weeks ago.

Theoretically, the market is in better shape heading into this week of trading. The low of October 10th was retested last week and bounced. The major indexes actually gained off the lows: the Dow Jones Industrial Average gained 4.7%, the Standard & Poor’s 500 index was up 4.6%, and the Nasdaq Composite index rose by 3.7%. Granted, that was small in comparison with the previous week’s losses, but we have to start somewhere.

Some of the leading sectors presented some surprises. Health Care Select Sector SPDR (Amex: XLV) gained 9.4% to lead the ten major sectors of the S&P 500. After breaking support at $30, this ETF fell approximately 20%, to near $24, before rebounding.

Utilities Select Sector SPDR (Amex: XLU) gained 8% and was another surprise leader. XLU formed a head-and-shoulder pattern, breaking to the down side on September 26th. The downside target was $25.50, which was reached easily with the broad market sell off. Both sectors are worth watching near term for a continuation of the bounce off support.

Technology Select Sector SPDR (Amex: XLK), up 4.2%, and Energy Select Sector SPDR (Amex: XLE), up 5.2%, showed they weren’t dead yet. Some analysts have been raising their ratings on technology stocks to a buy. Future earnings guidance is a challenge for this sector. Sure, the P/E ratios look cheap on a relative basis, but without some clarity on the next few quarters, it is a tough buy, in my view.

Energy is in the same boat for now. The cry for oil prices to rise again may be legitimate, but in the short term the bears are in control. The move below the $70 mark last week was symptomatic of the challenges facing the sector as sentiment towards oil remains negative. I am willing to wait for the outcome of Friday’s emergency meeting of the Organization of Petroleum Exporting Countries (OPEC). I don’t believe they can do anything significant at this point, but they can turn sentiment through words more than actions.

Last week’s two big losers were the Consumer Discretionary Select Sector SPDR (Amex: XLY) and the Materials Select Sector SPDR (Amex: XLB).

The retail sector continues to be a drain as seen in the September sales data, which fell for the fifth consecutive month, down 1.2%. Expectations of a slow holiday season are definitely getting priced in at this point. The outlook isn’t pretty, but then that could be a set up for the sector to surprise on the up side.

The basic materials sector, on the other hand, is oversold. The move lower has been prompted by a worldwide recession and a slowing in spending, including infrastructure. All of that may be true now, but I would watch for a bounce off the near term lows and a push towards the $29.50 mark on XLB. (Incidentally, these sectors’ performance is updated daily on SectorExchange.com.)  

Overall, the markets are still building a base/bottom. As I have stated many times, bottoms don’t just happen; they are formed over time. Looking back to the last correction in 2002, the bottom started being formed in October and was completed when the up trend was established in March 2003.
That said, there were tradable moves in the process of building the bottom. That is where we may find ourselves now, building a tradable bottom.

Jim Farrish, founder and editor of Melbourne, Florida-based SectorExchange.com, writes regularly about sectors and speaks widely about investing and money management.

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