The Market Prepares for a Stress Test

05/04/2009 10:48 am EST

Focus: ETFS

Jim Farrish

Founder and CIO, Jim's Notes

Jim Farrish, editor of SectorExchange.com, says the bulls will face their own challenge this week as banks' stress-test results and the April jobs report are released.

Nine of the ten major sectors in the market ended the week higher, but the one that didn’t bears watching: Financials ended the week down 2.3% as the banking stress test announcement created some selling.

A shift in leadership was noteworthy as utilities gained 4.3% and basic materials were up 3.8%. In fact, the Dow Jones Utility Index closed above the 340 resistance mark, while the Dow Jones Basic Materials Index confirmed the move above resistance at 161, and extended the uptrend. Both moves are bullish.

The table below (which is updated on SectorExchange.com nightly) gives the outlook for the exchange traded funds (ETFs) representing these sectors, with their support and resistance levels.

The leaders have been technology, semiconductors, networking, financials, banks, broker/dealers, and industrials. Except for financials and banks, the balance continued higher last week. They all remain in an established uptrend, having provided the necessary leadership for the broad market over the last eight weeks.

As for relative losers, health care, consumer durables, telecommunications, and energy continued to move sideways. If the trend is going to gain any up-side momentum, one or more of these sectors will have to take on a leadership role.

Nonetheless, investors continue to face three key challenges: The market is overbought technically; it is hitting against resistance in the major indices and sectors; and there is consolidation at the resistance points without the necessary momentum to break higher.

These concerns are why I remain cautious in the near term. If the market surmounts these obstacles soon, we could achieve the next leg higher before any meaningful pullback. How they move this week will provide some insight into the overall direction and trend.

The economic data continue to improve in baby steps, and those baby steps are resulting in the current optimism. Investors are gaining confidence that stocks have hit a bottom and the worst is over.

But are we pricing in better days ahead too soon? We won’t know the answer to that question for a while. In the meantime, you should take what the market gives you, evaluate the risk of your positions relative to the market, and set your stops according to the risk you are willing to accept.

Remain cautious, as risk continues to rise short term. In my view, risk management is money management.

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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