Will the Uptrend Continue?

05/26/2009 10:40 am EST

Focus: ETFS

Jim Farrish

Founder and CIO, Jim's Notes

Jim Farrish, editor of SectorExchange.com, notes that the market's rally is being threatened by growing fears about the economic recovery and the federal deficit.

Trading was sloppy last week as the market showed indications of a pullback. Technically speaking, the uptrend is still intact, but we have bounced off support for the second time in as many weeks. The pattern set up is a double top. Taking out support would complete the pattern and clear the path to the downside. 

Fundamentally, the market is challenged by the lack of significant improvement in the economic data. In fact, the minutes from the Federal Open Market Committee meeting showed a revision downward in the growth projections for gross domestic product (GDP) for the second half of the year.

I think the data are improving enough to have prevented the death spiral to which the economy appeared to be headed in February-but not enough growth to support the current price of some stocks and sectors. This leads me to a very cautious stance in the short run.

Taking the fundamental outlook one step further, the debt ratio is rising with the 2010 projections at 70% of GDP. This is the 1970's being played out all over again. The similarities are uncanny, and thus, some fear is creeping into the stock market.

Last week, semiconductors showed signs of exerting leadership again. That would be a plus for the broad markets, since they have been one of the original leaders off the March low.

Energy, commodities, and gold have moved up on renewed fear of inflation. I think this is more of a trade than an investment, so take what the market gives, but don't overstay your welcome.

Despite all the negative sentiment and market decline, we ended the week to the upside. The ten sectors in the Standard & Poor's 500 index were mixed: Six closed lower and four closed higher. The biggest loser was telecommunications, down 3.7%. The winner was consumer discretionary, up 1.1%. The majority were flat on the week, underscoring the indecision on behalf of the investor and their ability to hold support.

Interest rates showed some vigor, as the ten-year note's yield jumped to 3.44% by week's end. The fear of inflation and the devaluing dollar didn't help much in this area. In fact, the dollar index declined to 80.1, with support at 79.5, and this has not been a pretty picture over the past few weeks. And lest we not forget, a weak dollar also will wreak havoc on the price of oil and gasoline. Throw in gold moving back near the $1,000 mark and you have the underpinnings of a pullback.

The rising percentage of debt relative to GDP also added speculation that the US's credit rating could be downgraded, as S&P lowered the UK's rating to "negative" for the same reason. The ten-year Treasury note responded by selling off, while its yield jumped higher. None of this is positive for the economy or the stock market.

For now, though, the upside is intact, and you have to lean in that direction. If we take out support, the short side will become more attractive as the momentum and trend will have shifted.

The table below has been updated to reflect last week's move. We update this data each night on SectorExchange.com under my blog, "Jim's Notes." 

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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