Has the Down Trend Been Broken?

12/08/2008 12:25 pm EST

Focus: ETFS

Jim Farrish

Founder and CIO, Jim's Notes

After a week of directionless trading, buyers stepped up Friday.

The bulls are trying to assert themselves on the premise that lower mortgage rates will be the catalyst to the economic ship righting itself. Housing remains an important part of the equation and the economic picture isn’t going to improve without it at this point.

Friday, investors looked at some of the worst news since the last jobs report, and they bought stocks. This created some short covering and a rally into the close, which continued overseas and into the opening Monday.

This could be the signal of the market being sold out at least for the short term. A quick look at sector exchange traded funds (ETFs) gives some insight into where the leadership resides currently.

The S&P Select Consumer Discretionary SPDR (NYSEArca: XLY) hit a low of $16.20 on November 20th and has rallied back to $21.09 on Friday’s close. The fund has shown a solid move to the up side, providing short-term leadership.

S&P Select Financial SPDR (NYSEArca: XLF) similarly hit a low of $9.29 on the same day and has moved to $12.81 on Friday. I like the leadership from both of these sectors off the lows. While they have been hard hit by all the selling, they are also showing signs of leading the broad market higher.

The key has been mortgage rates dropping back below the 5.5% mark. Also, the government may put up another $800 billion to stand behind troubled assets with Fannie Mae and Freddie Mac. The continued government backing of Citigroup and AIG added some confidence as well. Since this all hinges on confidence in the financial markets, that’s why we’ve seen the current bounce despite much bad economic news.

Utilities, telecommunications, and health care are sectors on the verge of breaking higher from their current trading ranges and consolidation patterns. Overall the momentum is picking up, and the bad news is being dealt with as some optimism is creeping into the markets. 

iShares DJ US Telecom Sector Fund (NYSEArca: IYZ) is attempting to complete a double bottom, and this would assist the broad market to the upside. S&P Select Utilities SPDR (NYSEArca: XLU) is trying to break through resistance at $29.79 and is adding to the up side momentum as well. Healthcare Select SPDR (NYSEArca: XLV) has bounced off the low and has moved higher in an effort to break the short-term down trend. Sub-sectors biotechnology and pharmaceuticals have assisted in the push higher.  

On the down side, energy was impacted by crude oil moving lower last week by $12 per barrel, or nearly 23% on the week. I continue to watch this sector for a potential bounce off the new lows. The Organization of Petroleum Exporting Countries (OPEC) is meeting on December 17th and will likely cut production more. If stocks rally, look for the price of oil to bounce.

This week I continue to look for a rally in financials. Take note of SPDR Series KBW Bank Fund (NYSEArca: KBE) and a break through resistance near $24. Brokers rallied more than 10% on Friday along with insurance, and they will be key to a continued rally in the broader financial sector. Housing, real estate, and homebuilders enjoyed a nice bounce from the lower mortgage data and the higher application report on mortgages. Watch for that trend to continue this week.

The international markets have struggled more than the US of late and the country- specific ETFs have dropped to new lows. I like the chart of iShares FTSE/Xinhua China 25 Index (NYSEArca: FXI), which broke above resistance at the $27.40 mark. Look for a follow through to the move this week. The balance of these ETFs continue to trade sideways, but could move higher in unison with the US. 

Nonetheless, the trend of the broad market is down. Short-, intermediate- and long-term charts show down trends firmly in place. The old adage of don’t fight the trend is key here. While we may be more optimistic about the short-term outlook, it is important to follow the leaders and track the strength of the market rather than try to call the bottom.

If you look at charts, you see the accelerated turn down starting in September. This trend remains in play, but any break of that trend could offer some short-term opportunities. The ETFs that have momentum are where I would put money to work. But because the overall trend is still down, you need to trade with the discipline of an entry and exit strategy with clear target prices. Without discipline, this volatile market will punish you.

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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