5 Big Tests for Fast-Rising Sectors

01/16/2012 12:50 pm EST

Focus: ETFs

Jim Farrish

Founder and CIO, Jim's Notes

Upcoming earnings announcements are among the important factors that will help determine the short-term outlook for standout sectors like financials, housing, telecom, utilities, and gold.

The market is making methodical progress in the move higher. As we complete the second week of trading in the New Year, we find plenty to like about the markets currently and looking forward.

That said, however, there is equally as much to be concerned about in the short term. The major indexes have made solid gains to start the year. The Nasdaq index has been the clear leader with large caps forging the way.

Are investors ready to add risk to their portfolios? The commitment to stocks remains a question mark, but they are gaining in popularity for now. Financials and housing are two sectors showing solid moves off the October lows, but more importantly, they are the foundation for a stronger economic picture, and thus, they’re important to a sustainable advancement of the broad markets.

If those sectors can sustain their upward trek, we have a good chance of holding the gains and making further progress throughout the year.

Some ideas to watch as we begin this week:

  • Response to financial sector earnings. This is one of the keys to the earning season for me. I know that some of you look only at technical data, but the fundamental improvement in the financial stocks could be the confirmation and extension to a break higher for the S&P 500 index. It will also go a long way in improving the sentiment towards the markets overall.

    JPMorgan Chase (JPM) announced earnings on Friday, and we will look through the data for clear signs of improvement relative to balance sheets and forward guidance. The bank stocks start this week as well with Bank of America (BAC) and others, and they will give input on the lending outlook. Are things improving? Are the balance sheets getting better?

    Watch the outcome for insight from the data and a boost to confidence if the numbers are positive.
  • Housing is improving. The housing sector is improving and the stocks have moved to the July highs, but the key is the overall picture. The rumor of bundling and liquidating foreclosures off Fannie Mae and Freddie Macs balance sheets sounds positive on the surface, but it could add another dimension of challenges for the housing market short term.

    I like the fundamental improvement in the homebuilder stocks. There balance sheets are cleaner, revenue is picking up, and the margins are improving. There is a positive outlook fot the sector, but more importantly, this acts as a confidence builder for the US economic picture.
  • Mixed signals from energy sector. Energy has been a mixed bag to start the year. The ups and downs in the sector continue as the earnings warning from Chevron (CVX) set the sector back. A look at the Select Sector SPDR - Energy (XLE) shows a test of support at $69.75 and the 50-day moving average (MA).

    The challenge for the conglomerates is the refinery business and the ability to adjust for the higher price of crude. Oil has made several attempts to move above the $103 resistance, but has failed to find the momentum to sustain a move. Demand has not been a pressure for price, thus, speculation is the driver.

    The services sector continues to struggle as well relative to growth. Demand plays a key role in the service stocks moving higher. This is a sector to watch on the downside in the short term.
  • European debt crisis. Europe remains on the watch list of issues facing the markets overall. It has been relatively quiet on the news front, but that isn’t always a good sign. The bond auctions have been positive so far this year, but there are billions still to be refinanced in Italy, Germany, France, and Spain.

    Yields have held steady, but the concern is that they will start to rise again at the first sign of trouble. If—and that is a big if—the sentiment improves, there could be some opportunities in the global markets.
  • China released positive data this week relative to their economic picture. That has helped stocks bounce off the lows and has pushed gold prices higher. The improving economic picture in China has some gold speculation that inflation will heat up. Not sure of the latter, but the improvement in stock prices is a side effect of an improving economy.

    This is a country to watch in the short term for some upside opportunities. The SPDR S&P China ETF (GXC) broke the short-term downtrend line, and a move above the $66.10 mark would be positive technically.

There are multiple issues swirling around the markets, and they all have various levels of concerns. For investors, it is essential to stop, listen, and evaluate each relative to the reality.

NEXT: Latest Sectors on the Move

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Build watch lists based on these concerns or issues. Track them to determine there current and future impact. Look for the resulting opportunities from each. It is easy to take each of the issues discussed briefly above and build a list of stocks, ETFs, mutual funds, etc. to track based on each. They will show you what is taking place day-to-day with their respective trend lines.

When analysts or speculators create turmoil or worries, build a watch list and track the resulting opportunities from the pending outcome. Stay focused and disciplined in managing your portfolio. Don’t make assumptions about anything, validate everything, and stay focused on your goals relative to investing.

Latest Sectors on the Move

Financials have moved to the October high of 260 on the Dow Jones US Financials Index and above the 200-day exponential moving average (EMA). Thus, resistance to watch is again on the upside. The financial sector, as discussed above, is one of the key components looking forward.

Regional banks (KRE) are at the July high and testing the opportunity to move higher, setting the pace for the sector. The SPDR KBW Bank ETF (KBE) moved above the 200-day EMA and is looking for a catalyst to break higher. Watch for a potential test before making a bigger move higher. 

JPMorgan Chase announces earnings on Friday, and that will give a glimpse into the future of the sector short term. Make sure your stops are in place to manage the risk and protect the profit. 

The Dow Jones Basic Material Index posted a big gain of 4.2% last week. The metals and mining stocks benefited from the Alcoa (AA) earnings announcement and broke the short-term downtrend line off the November high. The short-term target is that mark of 284. The sector breakout from the wedge consolidation pattern is in play and the momentum has picked up. Be patient with this process and manage your risk accordingly.

Telecom is attempting to break from the longer-term trading range. The iShares DJ US Telecom Index Fund (IYZ) made a move above $21.40 on Thursday and is worth watching short term for a move towards the 200-day moving average. Telecom is a sector worth researching in order to find the leaders and buy those stocks. They will give the better of the move going forward.

Gold continues to move higher off the low at $1524 and the outlook is positive short term for the precious metals. The SPDR Gold Trust (GLD) pushed above the $158 mark and the follow through has started a move towards the $1663 level. Be patient and don’t anticipate or force positions on this move.

The Dow Jones Utilities Index tested support at 170 and is holding. Technically, this is an important support level short term. It holds the 30-day EMA, the uptrend off the December low, and the break above the previous resistance at the 170 level in November/December. Looking for a bounce off this mark and an opportunity to add a position based on growth and the dividend play in the sector. Use patience as this plays out.

Industrial stocks made a solid move above resistance at the 313 level with the follow through this week. Look for some resistance at the 327 mark. This would put us near our initial target on the sector, and thus, adjust your stops and look at taking some profit from the positions. Disciplined trading is key to successful money management. 

The retail sector index is stuck at resistance near 413. The top end of the trading range is in play again. The challenge has been stocks like Urban Outfitters (URBN) dropping 18% on news the CEO is retiring. This remains a stock-picking sector, but it is also important to investors’ psychology to know the consumer spending and the stocks are performing. Watch the SPDR S&P Retail ETF (XRT).

The markets have gained some upside momentum, but we remain cautious and continue to monitor stops to manage the risk of the current market environment. Watch and play according to your risk tolerance.

Everyone has different trading styles, and you have to find what works for you and your personality. Don’t put yourself in positions you don’t understand or take risk you can’t tolerate. Not every trade results in a profit, but controlling your downside risk determines your long-term results. Trade smart!

By Jim Farrish of SectorExchange.com

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