Technology Sector In-Depth

04/23/2009 12:01 am EST

Focus: STRATEGIES

Thomas Aspray

, Professional Trader & Analyst

The rally from the March lows has been impressive, with the S&P 500 up 30%, and technology has been one of the strongest sectors. In this article, I will concentrate on the various sub-groups that make up the technology sector, as well as look at a few stocks in these sub-groups.

Table 1

The performance of the technology group this year has actually been quite good as through the April 17 close, the S&P 500 is still down 3.7%, but the information technology sector is up 13.3%. Two sub-groups have done significantly better, with Internet Software up just over 22% and Computer Hardware up almost 20%.

Since the March lows, the technology sector has been just a bit better as the strength in the financials has contributed a great deal to the rally in the S&P 500. If the March lows constitute a major low (from my view it is too early to tell), then these sub-groups could contain the stocks that will be the leaders in the next major up cycle.

Figure 1

Let's look at the weekly analysis of the sector first, and as we noted on March 4th, the RS moved through multi-year resistance at line 2. The resistance from early 2002, line 1, was reached in mid-April. The weekly chart shows a potential double-bottom formation, and should the overall market retest its lows, this sector should hold above these lows. The WMA on the weekly RS is also rising sharply, which is another positive sign. The daily chart shows that in December, the RS tested the lows from early in the year, line 6, and then moved through its four-month downtrend, line 5, in January (line a) and has continued to stay strong. The sector dropped to a low of 199 on March 9, but held above the November lows at 198. The rally from the lows was impressive as the daily downtrend, line 4, was easily surpassed on March 23. The sector is now very close to the declining 200-day MA, so a pullback would not be unexpected. The major 23.6% retracement resistance has been surpassed, with the 38% resistance now at 290. The more important 50% retracement resistance from the October 2007 highs lies at 320.

Figure 2

The best looking sub-group from both a RS and chart basis is Computer Hardware. The long-term weekly chart shows that support going back to 1996, line 2, was tested in late 2008 and early 2009. The RS chart is equally interesting as the steep uptrend, line 3, was broken in the latter part of 2000, indicating that this group was no longer outperforming the S&P 500. The RS between 2001 and 2005 developed a long-term base formation as indicated by lines 4 and 5. There was a minor breakout from this trading range in early 2007 that was confirmed in the middle of the year as both the RS and its WMA were rising sharply. The RS is now in a solid uptrend, line 6, and pullbacks to this uptrend and its rising WMA should present good buying opportunities in this group. The chart shows first significant resistance at 450 with more important resistance in the 500-550 area.

Figure 3

Western Digital (WDC) is one of the hardware stocks that has already had a great run from the March lows of $12.64 as it closed on April 17 at $22.42. The bottoming action over the past six months has been quite interesting, and here are some of the facts: The lows in March were well above the November lows of  $9.48 (a positive); the November lows tested two converging levels of support, lines a and b that go back to 1999; and lastly, even though the uptrend from 2001, line c, was broken in November, it was just tested in March. Volume has been strong on the recent rally as the OBV, after also testing multi-year support at lines d and e, has risen well above its WMA. The 38.2% resistance level has already been overcome, with the 50% level and the former uptrend now in the $25 area. The 61.8% resistance level is just below $29. Clearly, on a short-term basis, WDC is overextended and I would only consider buying on a significant pullback with important support lying in the $16.50-$17.50 area.

NEXT: Software, Semiconductors, and More

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Figure 4

The weekly chart of the Internet Software group is a good example of a full RS cycle. From 2000 to early 2002, the RS was in a well-established downtrend, line a, and its WMA was also declining. The group made its lows in 2001 and then successfully tested those lows again in 2002, line c. A similar range was evident in the RS, though it broke through resistance, line d, several weeks ahead of prices (point 1). Both the group and the RS were in a steady uptrend for the next three years before peaking in late 2005. Several weeks after the highs, the RS dropped below support at line e, indicating a change in its relative performance (point 2). Though the Internet Software group did rally along with the market into the October 2007 highs, the RS line was lower, line f. This three-year resistance has now been slightly overcome and the fact that the WMA is rising is encouraging. A convincing breakout is very possible in the near future.

Figure 5

McAfee (MFE) looks well positioned to be a star performer if this group does break out to the upside. The weekly uptrend that goes back to the 2002 lows was slightly exceeded last November and tested again in March of this year and continues to represent important long-term support. The weekly OBV has already broken out to the upside (point 2) as it moved above 18-month resistance at line e. Its WMA is also rising, which is a positive sign. The OBV has done fairly well in identifying past turns in MFE as the break in the two-year downtrend, line c, in late 2003 (point 1) preceded a rally from around $15 to over $32 per share. A similar breakout in 2007 (line d) also caught a nice move to the upside. There is significant resistance now in the $40-$42 area and a good band of support at $28-$32. A close below $24.50 would violate the weekly uptrend and obviously be negative. It should also be noted that MFE's main competitor, Symantec Corp (SYMC), also looks very strong.

Figure 6

The Communication Equipment sub-group (computer networks such as LANs and WANs) also did not make new lows in March. The daily chart shows that the five-month downtrend in the RS, line d, was broken in January (point 1). By early March, point 2, the RS had moved through the resistance from the October 2007 highs, line c. After moving through chart resistance at line e, the group rallied another 15% and is now testing its declining 200-day MA. The daily chart shows much stronger resistance in the 100-105 area, lines a and b.

Figure 7

The S&P Semiconductor group also did not make new lows in March as the daily chart shows the completed bottom formation, lines c and d. The rally is now approaching the initial downtrend, line b, at 235 and there is much stronger resistance in the 280-310 area.  The daily RS moved through its short-term downtrend, line f, in February, and more important resistance, line e, was overcome as the major averages were making their lows in early March. The RS line has flattened out over the past two weeks, which increases the chances of a pullback. Good support in the 200-210 area and only a break below line d would abort the bottoming formation.

Figure 8

Many of the semiconductor stocks have already had dramatic rallies, and while we have not seen strong weekly positive signals on Varian Semiconductor Equipment (VSEA), it does have an interesting pattern. In November 2007, VSEA dropped down to test converging long-term support in the $14 area, and it held above those lows in March, line d, as the low was $15.96. It has rebounded about 50% from these lows and has overcome the steep downtrend, line a. The weekly OBV is just barely above its WMA and needs to move through the downtrend, line e, to indicate a new weekly uptrend has begun. Late last year, the OBV did test support from 2000 at line f. There is first good chart support in the $19-21 area with longer-term support in the $17-$18 area.

In conclusion, the weekly analysis of the technology sector does look promising and suggests this is a sector that should be watched closely whether the overall market moves higher from here or not. If the market continues higher from current levels, technology is likely to lead the way, but if the rally stalls in the next month or so and the major averages again drop back towards the March lows, I would expect the technology stocks to hold well above their March lows.

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