Prepare for a Pullback

04/20/2009 12:06 pm EST

Focus:

Jim Farrish

Founder and CIO, Jim's Notes

Jim Farrish, editor of SectorExchange.com, says the tone of the market remains bullish, but says it can go higher only if financials and technology continue to be leaders.

Six weeks to the up side and investors remain bullish. The technical data all point to an overbought market, but optimism and confidence are pushing the Nasdaq Composite and Standard & Poor's 500 indices higher. In fact, both are attempting to break above the January high and set the stage for the next leg up in the current trend. (Stocks were selling off Monday morning, however, on profit-taking and new concerns about financial stocks—Editor.)

The push higher has many analysts puzzled, but as long as both technology and financials continue to set the pace, the up trend will remain. The very same news that caused the markets to sell off from their January high is still in place; the difference is perspective. Then the glass was half empty, now the glass is half full.

The American Association of Individual Investors' sentiment indicator shows 44.1% of its members who responded are bullish, versus only 18.9% on March 5th. The swing is an indication why the trend remains to the up side.

Last week, financials led, gaining 3.3%. Industrials weren't far behind, up 3.2%. Energy, telecom, and utilities all turned in a small negative return for the week. Since the March 9th low, financials have been the winners, up 69%. Basic materials and industrials tied for second, up 38%, and then came technology, which rallied 32%. (For the calendar year, however, financials are down 28.6%, industrials have fallen 19.8%, basic materials are off 1.8%, and technology has risen 1.9%.) 

Where does this leave us for the immediate future? Cautious is the only word I have been able to use personally. I, like many investors, want to maximize this move to the up side. However, we have to be realistic, so I have adjusted my stops almost daily over the last two weeks as the risk continues to increase short term.

What am I watching now? One of the data points I find of interest is the lack of improvement in the economic data relative to the move higher. I understand the market trades looking forward and most of the economic data is backward-looking back. Still, I just don't see the kind of improvement that justifies the current move.

I am watching the leadership from technology and financials as an indicator near term. In addition, 875 is the resistance point for the S&P 500 while 1682 is resistance for the Nasdaq. Technology leads the Nasdaq, while financials lead the S&P. If they falter, look for the major indexes to struggle with resistance near term. If their leadership continues, watch for the next leg higher.

The table of ETFs to watch has been updated to take into account last week's move. Raise your stops and be disciplined: This market is due for a pullback and you want to be prepared. To quote Will Rogers, "You can be on the right track and still get hit by a train."

Last week I was looking for the following three things for the market to move higher, and I have updated them:

1. Break above the 875 mark on the S&P 500 to validate a continuation of the uptrend. If we fail, look for a retreat near the 800-820 level of support.

2. Continued leadership from financials and technology (see above). If they pull back, look for the rest of the market to follow. If they run higher, it will provide the leadership for the next leg higher.

3. Earnings remain in the forefront. They may point the way for the rest of the market.

Know what your strategy is relative to your portfolio now, before a pullback takes place. Where are your stops? How much down side risk are you willing to accept at this point? Knowing that now will make your decisions easier if and when the pullback begins.

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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