Breaking the Market’s Logjam

06/22/2009 10:24 am EST

Focus: ETFS

Jim Farrish

Founder and CIO, Jim's Notes

Jim Farrish, editor of SectorExchange.com, says nine out of ten sectors lost ground last week, and he tells what will need to happen to resolve the market's current impasse.

Last week, the Standard & Poor's 500 index fell 2.6% amid higher crude prices, weak consumer spending, and the threat of higher interest rates. The inflation issue was put on the back burner, however, as the CPI (Consumer Price Index) and PPI (Producer Price Index) showed no immediate signs of price hikes.

Uncertainty about the future growth of the economy remains the number-one challenge. What happened to all the confidence we'd seen over the last 12 weeks? The reality is the economy is still producing at recessionary levels. Yes, the economic data have improved, but they aren't showing signs of growth fast enough to keep pace with stock prices. In other words, the market is ahead of itself.

Basic materials led the way on the down side, losing 7.1% last week. Energy fell 6.9%, and industrials were down 5.1%. In fact, nine of the ten major sectors were negative for the week. This was the weakest data since the March 9th low. Health care was the only sector to end in the green, up 2%. Health care, of course, is a defensive sector, so the money flowing into those stocks clearly was looking to avoid risk.

We remain in a trading range with below-average volume. This is likely to end in a sharp break out up or down. I still give equal probability to either side, but my near-term bias is towards a test of the bottom of the range at 875 in the S&P. The weak volume doesn't bode well for a break to the up side.

Leadership is a big question mark as technology, commodities, and financials took a break again this week. Each have formed tight consolidation patterns over the last three weeks, and have shown no short-term signs of moving higher. The inflation trade in commodities weakened further, with the CPI data showing no current inflation.

Without confidence about the future, the market tends to trade in a range awaiting the next catalyst, good or bad. The list of potentially bad events is building: The weak dollar, higher interest rates, higher commodity prices, political issues such as health care, and geopolitical concerns such as Iran and North Korea all are potential catalysts for further downward moves in stocks. 

What could help push markets higher? Improving economic data such as the LEI (Leading Economic Indicators) and second-quarter earnings are potential catalysts. The challenge for investors will be having the patience to see which has the stronger hand.

All of this adds up to more volatility in the broad market. There is more economic data on tap this week, all of which may break the consolidation log jam. Watch the volume and investors' confidence as keys to resolving the current trading range.

I have updated my ETF watch list to reflect where I see the potential moves up or down. My focus is to capitalize regardless of the outcome.

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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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