Financials Take the Lead—Again

04/13/2009 11:09 am EST

Focus: ETFS

Jim Farrish

Founder and CIO, Jim's Notes

Jim Farrish, editor of SectorExchange.com, says that Wells Fargo's surprisingly good earnings sent stocks higher last week, but he wonders if the move will last. 

Technically speaking, Wells Fargo's preannouncement of earnings pushed the market higher last week and may have ignited the start of the next leg higher.

I'm not one to look a gift horse in the mouth, but we have to ask if this rally has legs or whether we will pull back from here. The logical person in me says take the money and run. The emotional one says the bottom's in and we are heading higher. Thus, I have to balance the two and use discipline to accommodate both.

The broad markets for the week were lower before Thursday's open. Then the news from Wells Fargo hit the airwaves and the rally was on. Financials gained 13.5% on the day and ended the week higher by 7.7%. The breakout move was impressive, leading the index through resistance and starting the next leg higher in the current rally off the March lows.

You know my next question: Will the rally hold? I'd rather ask whether we have more risk to our portfolio in light of the move higher on Thursday. My view is: yes! Money management is not about predicting direction; it is all about risk management. If I manage the risk, regardless of the market's direction, I will be a better investor over time. To quote Will Rogers: "I am more interested in the return of my principle than the return on my principle."

The Nasdaq 100 index has been one of the leading indices over the last five weeks, and I invested in it with PowerShares QQQ Trust ETF (Nasdaq: QQQQ). The chart below, reprinted with permission of Worden Brothers, shows how I am managing the risk in my portfolio.


 
A break of the down trend line off the March low-$28-was the signal for the entry. My stop was initially $25.50, just below the low of $25.72. My target was $34. Thus, I decided how to get in (entry), where to get out (stop), and where I was going (target) before buying. This simple exercise takes the emotions out of play.

But based on Thursday's move higher, I have raised my stop to $31.25. My logical side is willing to accept that much downside risk, while my emotional side is prepared for the position to go higher should the market move more. By managing the risk of the position relative to the market, I am managing my money relative to my goal and my risk tolerance.

As we scan the ten sectors of the Standard & Poor's 500 index, we find that four broke through resistance and continued their market leadership, while the other six are limping or laggards. Current leaders technology, financials, consumer services, and industrials each started their next leg higher on Thursday. This week, we'll see if they can maintain their momentum or retreat back below the breakout levels. This will be one of the keys to the market's direction in coming weeks. If they continue higher, look for the other sectors to tag along and join the up-side breakout.

In each of these sectors it is important to redefine support levels. This allows you to determine the level of the potential pullback and manage your risk. The table below gives my view of the support levels and outlook for each of the sectors I am currently tracking.

I'm watching three things this week:

  1. Can we maintain the breakout moves? If we don't and stocks retreat, look for more consolidation and a pullback to support. It could be the 20- or 50-day moving average depending on how emotional investors get in response to any selling.
  2. Continued leadership from financials and technology. If they move higher, it will provide the leadership for the next leg up in this bull run. If they pull back, look for the rest of the market to follow.
  3. Watch earnings. They are center stage this week-companies like Citigroup (NYSE: C), Goldman Sachs Group (NYSE: GS), General Electric (NYSE: GE), and Intel (Nasdaq: INTC) all report—and will determine the market's direction.

Be patient with your positions. Find support and set your stops according to the risk you are willing to accept. Don't allow your emotions to overcome your discipline.

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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