Some leadership breakouts and laggards emerging slowly

The market is setting up for a test of the first important resistance level since this rally began in mid March.  Chart 1 shows the S&P and the critical 1395-1405 resistance level that represents the February highs and the lows of November.  A strong volume and breadth breakout above this level would setup a further rally to the 200 ma up to 1455 resistance potentially.  However we’ve already had 2 distribution days (1% or more declines on higher volume) in the major averages and another two, or a 90% down-day (down volume being 90% or more of up + down volume AND declines being 90% or more of advances + declines) would suggest that this bear market rally is over and the lows will be tested or broken as a new leg down develops.  The action ahead is therefore critical.

Chart 1:  S&P approaching first critical resistance zone at 1395-1405 – let’s watch carefully.  Courtesy Bloomberg

Whether or not this is a bear market rally, it may still be a catch-able one for nimble traders if the first resistance level can be taken out.  Internally the market is still questionable, but has been improving slightly.  Note that our Top RS/EPS New Highs list is rising, though still not consistently being 40 or more above our Bottom RS/EPS New lows list (see www.midasresourcegroup.com for daily updates and graph at bottom of article for weekly chart).  The environment is therefore not yet ripe for taking long side breakouts just yet, but it is slowly improving.

The number of close call breakouts that almost meet our criteria is also improving slowly.  This past week Steel and E&P ETF’s both broke out.  For those that haven’t yet taken an E&P (Oil Exploration and Production) industry breakout like HK or FST, the ETF XOP is one to consider.  E&P is the industry showing the most plurality of breakouts, and with oil making new highs and likely in a further wave up, this group should continue to lead on any market upside action (see chart 2).  XOP could be purchased by traders trying to exploit this potential bear rally in stocks with stops under the handle of its cup & handle pattern.

Chart 2:  XOP, the E&P ETF broke out amidst dominance in Top RS new highs by group.  Courtesy Bloomberg

The market is still not giving full evidence that it is safe to take breakouts with impunity however, so caution and defense should remain primary even for traders.  However further expansion in the net number of Top RS/EPS new highs above 40 consistently for many days, as well as a strong volume and breadth breakout by the S&P over 1405 would be good signals that a further rally is developing and that new breakouts close to or meeting our criteria that develop in leading groups could be taken a bit more aggressively ahead.

Until the market becomes more reliably directional and offers more and better trading opportunities cash and uncorrelated plays should continue to be explored.  One positive aspect to the incredible and wonderful expansion of ETF’s is that uncorrelated avenues previously unavailable to stock investors can now be exploited.  We talked about CNY the new Chinese currency ETF last week.  This week we’ll show how stock investors can buy a forex cross using ETF’s that is likely to continue gaining ahead, for more conservative and uncorrelated gains.

The Scandinavian economies are amongst the strongest in the developed world.  While the US, Japan, and Western Europe are slowing economically, Norway and Sweden remain strong with inflationary pressures, high employment, and resilient growth.  Central banks in these countries are likely to continue raising rates despite global turmoil because their economies are at nearly overheating levels.  In contrast the UK economy seems destined to follow the US into a severe growth slump.  It has experienced a property bubble at least as bad as the US’s, retail sales and growth indicators are dropping fairly rapidly, and the financial sector is vulnerable to the credit crunch and sub-prime woes, while the AIM became the dominant international exchange of the world and is therefore feeling the pinch as IPO volume slows dramatically.  The Scandinavian currencies of Norway and Sweden are thus likely to continue gaining on the British Pound.  Chart 3 shows the strong trend already in place and the trend channel that is likely to remain in force for most of the year in the cross of SEKGBP (buying Swedish Krona, shorting British Pound).  Now although this is much more advantageously taken in the forex market, stock investors could also emulate this cross buy buying the Swedish Krona ETF (FXS) and shorting an equal dollar value of the British Pound ETF (FXB) to make a pair trade.  The pair could be charted on programs like stockCharts.com (via FXS:FXB) and could be purchased with stops under the up-trendline in chart 3 on corrections in particular in the period ahead.  Like CNY, this trade is likely only a very small double digit gainer, but it is uncorrelated and is a way of potentially earning more on your money while you wait for a better stock environment.

Chart 3:  SEKGBP in consistent uptrend likely to continue and could be replicated with ETF’s.  Courtesy Bloomberg

E&P, Ags, and Steels seem to be topping our Top RS/EPS new highs list (you can access the list daily on www.midasresourcegroup.com).  However no valid trades have yet materialized and the number of Top RS/EPS stocks making new highs versus Bottom RS/EPS stocks making new lows (shown in chart at bottom of this column each week and accessible daily on www.midasresourcegroup.com) is not showing 40 new highs over new lows that we would like to label this a good buying environment yet.  So investors should only lightly buy dominant groups like E&P’s and mostly continue to wait, watch the new highs close to or meeting our criteria, and look for a better environment for more valid trades to develop potentially ahead.  Other groups should materialize and develop leadership more thoroughly as well.   The larger the plurality of stocks breaking out in a particular group, the more valid, reliable, and profitable breakouts in stocks meeting or close to criteria are likely to be.   Those wanting short hedges could look to Managed Care and Indonesian groups and breakdowns.

For many weeks now our long/short strategy has been nearly 100% on the sidelines and in T-bills.  This past week our trailing stops were hit to force us to take profits on short TIN.    Our suspicion remains that a more bullish bias in breakouts and leadership will develop in the period ahead – but it should be viewed as a trading opportunity only for now.  This past week in our US selection methods, our Top RS/EPS New Highs list published on www.midasresourcegroup.com had close calls (long) in GTLS, KOP, FLS, GENC, BDE, JST, no close calls on the short-side, and no valid trades.  This strategy is now 100% in T-bills and looking for valid breakouts to take ahead.  

For those not familiar with our long/short strategies, we suggest you

review my book “The Hedge Fund Edge,” my course "The Science of Trading," my video seminar, where I discuss many new techniques, and my latest educational product, the interactive training module. Basically, we have rigorous criteria for potential long stocks that we call “upfuel," as well as rigorous criteria for potential short

 stocks that we call "down-fuel." Each day we review the list of new highs on our "Top RS and EPS New High List" published 

on www.midasresourcegroup.com for breakouts of four-week or longer flags, or of valid cup-and handles of more than four weeks. Buy trades are taken only on valid breakouts of stocks that also meet our up-fuel criteria. Shorts are similarly taken only in stocks meeting our 

down-fuel criteria that have valid breakdowns of four-plus-week flags

 or cup and handles on the downside. In the U.S. market, continue to only buy or short stocks in leading or lagging industries according to our group and sub-group new high and low lists. We continue to buy new long signals and sell short new short signals until our portfolio is 

100% long and 100% short (less aggressive investors stop at 50% long

 and 50% short). 

The chart below continues to show that now both Top RS new highs (available on www.midasresourcegroup.com) and Bottom RS New Lows are at relatively low levels, and neither has an edge of over 40 versus the other – meaning that the environment is not yet very good for longs or for shorts, though continued improvement in Top RS/EPS New Highs will boost long-side potential ahead.  Let’s wait until leadership and the plurality of breakouts is more prolific before risking much precious capital in this treacherous environment therefore.  If top RS new highs can rise consistently to 40 or higher over bottom RS new lows ahead, we may get a brief environment that allows for some long trades to work as trades.  E&P ETF XOP or future E&P close calls would be among our favorite groups so far to exploit any further rallies.