Market Risk on the Rise

04/27/2009 11:22 am EST

Focus: ETFS

Jim Farrish

Founder and CIO, Jim's Notes

Jim Farrish, editor of SectorExchange.com, evaluates risk of the broad markets and the importance of protecting your profit.

Looking at this week's winners and losers by sector, we find basic materials held the breakout above resistance and comprised the top-performing sector, gaining more than 4% on the week. The $40 mark had been resistance for the iShares Dow Jones Basic Materials Index  (NYSE: IYM). Friday's close at $40.38 shows a nice move higher with above average volume. The interest in the basic materials sector has picked up with the outlook for a strengthening global economy. Whether your outlook for economic growth recovery is three months or 12, the sector is worth watching near term.

The risk of the market continues to rise. We are seven weeks into the rally from the March low, and there is no consolidation or pullback to really discuss. Technically, the broad market shows an overbought condition. As we all know, the markets can remain overbought for a long time depending on the confidence and investor sentiment towards growth. Thus far, investors remain willing to commit new money at each drop.

Last Monday, the broad market indices fell 3-4%. Investors stepped in the balance of the week, leading them back near even or slightly positive for the week. The major sectors ended mixed as well, with five in the red and five in the green. Breaking the sectors down, four remain in an uptrend and six are moving sideways to slightly down. This is flipped for six bullish and four neutral last week.

The leaders are very clear as technology, basic materials, financials, and consumer services all remain in an uptrend leading the broad markets. Industrials, consumer durables, and energy can't gain traction to the upside and remain in a sideways trend. Health care, telecom, and utilities are struggling and show signs of breaking down.

Because of lack of breadth in the sectors to the upside, it puts me more in the caution camp of a pullback than in the bull camp of the next uptrend starting. Thus, I have tightened stops and done what is necessary to protect principle and profit at this point.

Sentiment is bullish short term, but seems to willing to swing quickly on news. Anything concerning the financial markets, i.e. the infamous stress test, puts downside pressure on sentiment and selling accelerates. This, from my view, is a confidence factor. While confidence has improved, it is suspect about strength in the financial stocks.

The number one question I am being asked currently is "How do I play this current market?" With extreme caution and prejudice would be the best course of action. If you take new positions, do so with a defined entry, exit, and target in place. In other words, know what your plan is prior to adding the position.

We made it through last week's onslaught of earnings data and we have another one facing us this week. The bar has been set so low that many of the companies are reporting better than expected data. This is positive from a sentiment view, but not as great from a growth view. The outlook for the next six to 12 months remains sketchy. Growth is still a big question mark from my research and one that keeps me cautious. LEI (leading economic indicators) was published last Monday and were down -0.3%. This is the third month in a row that number has been negative. The data is looking out four to six months as growth. Not a good sign.

The sector ETF table below was updated to reflect what I am watching during this week of trading. This is updated nightly on my Web site if you care to follow the updates. Remain cautious and review your stops. Understand the current market risk relative to your portfolio and the positions making up your portfolio.

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