ETFs to Consider After the Fed Meeting

12/16/2009 12:01 am EST

Focus: ETFS

Deron Wagner

Founder and Head Portfolio Manager, Morpheus Trading Group

Scoring its fourth straight day of gains, the S&P 500 cruised to its highest close of the year on Monday. The Nasdaq and Dow followed suit as well. Most of the stock market's advance was the result of opening strength, as afternoon action was generally subdued. Still, higher turnover confirmed the gains. The Nasdaq Composite rose 1.0%, the S&P 500 0.7%, and the Dow Jones Industrial Average 0.3%. Playing catch up to the rest of the major indices, the small and mid-cap indexes again showed the most relative strength. The Russell 2000 and S&P Midcap 400 indices jumped 1.6% and 1.5% respectively. All the main stock market indexes closed near their intraday highs.

Total volume in the NYSE increased 6%, while volume in the Nasdaq was 4% greater than the previous day's level. Although trading remained below 50-day average levels, the S&P and Nasdaq still registered a bullish "accumulation day." Market internals finally improved a bit, especially in the Nasdaq. In the NYSE, advancing volume exceeded declining volume by a margin of two to one. The Nasdaq advance/decline volume ratio was positive by nearly four to one.

The star of the show yesterday was the Russell 2000 Index, which broke out above its range we illustrated in a previous commentary. It also showed conviction into the close, as the small-cap index finished at its absolute high of the day. The breakout is shown on this daily chart:

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Going into yesterday, one of several ETF plays we were considering was a breakout buy entry into iShares Russell 2000 Index (IWM). Despite the Russell breaking out above its range, we made a judgment call to temporarily hold off on the buy entry. Our primary reason for doing so is that we're seeing a lot of institutional rotation into large-cap stocks, particularly in defensive areas such as utilities (XLU) and healthcare (XLV). Since large-cap "defensive" stocks are the exact opposite of aggressive-growth small caps, we're a bit concerned there may be a lack of institutional accumulation to back the breakout in the Russell. We may still buy IWM on a pullback—if it continues to act well—but we're merely monitoring price action in the small-cap index for now.

The S&P 500 set its highest closing price of 2009 on Monday, but the index technically has not yet broken out above upper channel resistance of its sideways range that has been in effect for nearly five weeks. This is illustrated on the daily chart of the S&P 500 below:

Click to Enlarge

The chart above puts Monday's new closing high of the year into perspective. In actuality, the S&P has merely drifted back up to test resistance of the upper channel of its recent consolidation, marginally edging out its November 25 closing high. Nevertheless, it would only require a closing price five points higher to technically break out of the month-old range. The same is true of the Nasdaq and Dow, both of which set new 2009 closing highs yesterday, but remain at least a few points below the intraday highs of their recent consolidations. Since we focus on trading what we see, not what we think, we cannot assume the major indices will break out above the highs of their recent ranges until they prove otherwise.

Just as the main stock market indexes kiss their recent highs, the S&P futures are indicating a lower open in the pre-market session. Opening indications at the time of this writing are for the S&P 500 to open near the area of yesterday's low. Unless this changes before the opening bell, there will be a bit of overhead supply from yesterday that the market must contend with. One possible explanation for the pre-market pressure is a large overnight jump in the value of the US dollar index ($DXY), which is nearly 1% above its price at 4:00 pm ET yesterday (it trades continuously). In the December 11 issue of The Wagner Daily, we cautioned that a continued recovery in the US dollar would "hold the market hostage."

That day, the PowerShares US Dollar Bull Index (UUP) rallied nearly 1%, and it surprisingly didn't have much of an immediate effect on the stock market. If the possible disconnect remains, perhaps today's rally in the dollar won't hurt the stock market much either. Nevertheless, it would be surprising if stocks blast substantially higher right now, just as the US dollar is starting to mount a convincing rally that is likely to hold US equities in check.

By Deron Wagner of Morpheus Trading Group

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