The Long and Short of It

04/15/2005 12:00 am EST

Focus:

Bernie Schaeffer

Chairman and CEO, Schaeffer's Investment Research

Bernie Schaeffer is a one-stop research shop for those seeking a full understanding of technical, fundamental, and contrary analysis. Here he cautions investors about the blue chip arena but also finds a sector set to outperform over the long-term.

"The stock market is an accident waiting to happen, and a bear market is very likely to be upon us sooner rather than later. The worst of all possible strategies now is to be 100% invested in an index fund. The only reasonable route to survival as I see it is to invest selectively in areas of the market that have not excited Wall Street and that have attracted heavy wise guy short selling, while maintaining an aggressive cash reserve and some exposure to put options on the mega-cap blue chips.

"In our research of exchange-traded funds, I assess various sentiment indicators to find the best and the worst ETFs. At the top of my list of favorable ETFs, from this combined perspective, is the Russell 2000 iShares Index (IWM AMEX), which mirrors the performance of the small-cap-heavy Russell 2000 Index. While I am encouraged by the fund's long-term technical performance, I remain concerned above weak short-term price action, as the group's outperformance ended abruptly at the beginning of the calendar year. Another caveat to the fund's continued success is its declining put/call open interest ratio, which could have further downside potential. On the upside, however, short interest just hit record highs for the IWM, providing an attractive bastion of short-covering support. And from a relative-strength basis, the fund continues to look impressive through a wide lens.

"On the negative side, I see the Nasdaq-100 Trust (QQQQ NASDAQ) potentially being the most vulnerable fund from a long-term perspective, despite the possibility of a short-term bounce. The technology-based instrument's open interest pattern looks vulnerable, and short interest on the QQQQ has suffered a 'two-for-one split' from its early 2004 peak. Also, the Nasdaq Composite continues to struggle with psychologically significant resistance at the 2,000 mark. Finally, anecdotal sentiment in the media continues to laud the merits of the big-cap sector, offering a dangerous montage of complacency in my opinion. At this point, I'd be much more comfortable being long the small cap IWM while consecutively short the big-cap sector, rather than going along on a bullish limb to be solely long the small-caps."

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