Financials Lead Oversold Bounce

03/16/2009 10:37 am EST

Focus: ETFS

Jim Farrish

Founder and CIO, Jim's Notes

Jim Farrish, editor of SectorExchange.com, evaluates last week's financial-led rally and its ability to hold this week and beyond.

Who knew making money would be such a motivator to investors? CitiBank, Bank of America, JP Morgan, and Wells Fargo all announced they were making money in the first two months of the 2009 calendar year. The good news prompted a 10% move up for the major indices and the financial sector gained more than 32% last week.

Retail sales data was better than expected, and for the second month, showed a consumer willing to spend some money. The trade deficit was lower than expected, and the Michigan consumer confidence data was better than expected. Thus, economic data added to the upside for the broad markets as well.

There was plenty of conversation prior to last week's rally about the oversold state of the broad markets. In fact, the S&P 500 index was 35% below the 200-day moving average. All investors needed was a little good news to provide a bounce off extremely oversold conditions. The news came in the form of banks making money and slightly improved economic data.

Will the move higher hold? Is this a new uptrend in the making? I'm not sold on the fact, but it is worth watching. The S&P 500 index closed back above 741 and the 20-day moving average on solid volume. The NASDAQ closed above 1385 and the 20-day moving average as well, showing solid leadership. I would expect a test of the move at some point short term. How we fare on the test will be the answer to the question on establishment of a new uptrend.

The winners last week, in my view, are technology, healthcare, and financials. Healthcare and technology were not the highest percentage gainers for the week, but they are the foundation of the move to the upside. Financials were up 32.5% on the banks' news of making money for the last two months. The move was more of a relief rally than strength one, however. If-and it's a big if-banks can regain some of the lost confidence, they will be a key catalyst to a trend reversal short term. The technology and healthcare sectors are poised to win from an extended rally in the broad markets.

Other sectors to watch near term are basic materials, energy, and consumer services. The materials sector is gaining on the underlying strength in oil prices. Energy is ready to bounce, and everyone is watching the pot, so to speak, so if it begins to boil, look for a pop to the upside. Consumer services held the November low and moved back above the 20-day moving average. This is a wild-card sector that could gain momentum along with the economy.

One week of gains doesn't create a new trend. The optimism in last week's trading can disappear as quickly as it appeared. Caution is advised along with a defined strategy of how to play both the short-term move as well as the longer-term outlook.

The following is my watch list for the week. Review and take note of the key levels in play.

Key Watch Points:

Both the small- and mid-cap indices are hitting against resistance points. If they can gain enough momentum to push through and continue higher, it will provide the needed leadership for the broad markets. If they reverse, look for a test of the move from last week.

Energy is trying to make a move higher. Oil is the catalyst, but supply data continues to keep a short-term lid on the pot. From my view, there is pressure building to the upside. Once the data confirms what most are thinking (high oil prices), look for a solid push higher and a test of the previous high in the trading range (471 Dow Jones US Energy Index).

Consumers could provide a catalyst to the upside. The retail data was a surprise last week, but the consumer may be in a better mood if they see improvement in the economy and unemployment stabilizes. Not there yet, but it is a key point to watch.

As with any market, the key is having a disciplined strategy to capture the upside or downside moves in the market. Remain disciplined in this market, and don't overextend your capital!

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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