Market Wrap, Monday, 04/13/2009 Monday Deals help with the Sector Rotation by Robert Ogilvie Click here to email Robert

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The markets, S&P 500, the NASDAQ 100 and the Dow Jones Industrial Averages all opened weaker and then tried to bounce back into positive territory. By noon, eastern time, they all seemed to find some support and began their respective trek upward to hit highs not seen in months. Then, as with most days, volatility returned in the form of a sharp decline in the last half hour. For instance, the SPX dropped from 864 down o 858 in fifteen minutes. While this is less volatile than we’ve seen in recent months because we are becoming complacent with the volatility, it is a sudden drop which may be attributed to the rumor turned truth that Goldman Sach’s (symbol: GS) was going to announce their earnings a day early.

GS closed the day a strong up 6.27 points to $130.60 ahead of the earnings that were due tomorrow which helped the financial sector and market post a recovery after being down as low 2.7% and 1.3%, respectively. After the close, GS announced that it has raised $5.5 billion in a capital for a private equity operation even though GS previously stated that it doesn’t intend on raising any more capital though share offerings. GS earnings were $3.39 per share versus the $1.60 expectation. GS also used the early announcement to trim their dividend to $0.35 from $0.47 per share. With GS’ help, today’s advance in the financials (up 4.4%) put the sector down 11% year to date which makes them no longer the worst performing sector.

The worst performing sector now is the Industrials, of which General Electric (symbol: GE) is one of. GE is down 29% year to date while the industrials are down 15.4%. Even though the Health Care sector traded with gains throughout the regular session, they can’t get the credit for the slight advance today. Health care gained 0.3% amid support from Express Scripts (Symbol: ESRX) and WellPoint (symbol: WLP) on news that the two companies have signed a definitive agreement in which ESRX will acquire WLP’s NetRx subsidiaries for $4.675 billion. Shares of ESRX and WLP were up $7.64 and $3.24, respectively. Tomorrow will have the Health Care sector in our sights with Dow component Johnson & Johnson (symbol: JNJ) reporting their quarterly results in the morning. Today’s internals had the NYSE (NYA) up 0.63% or 33.84 points to 5410.28. There were slightly greater advancing issues with 1,723 versus 1,261 decliners on 1.48 Billion shares. The 50 day average for NYSE volume sits at 1.6 billion while the 200 day average is at 1.48 Billion. There was weakness found in the internals with new 52 Week Highs at 8 versus 73 new 52 Week Lows. As for the NASDAQ Composite, it closed only 0.77 points higher on 1.8 billion shares, which happens to be far less than the 50 day average of 2.22 billion shares. The NASDAQ, while barely higher on little volume managed to post more new 52 Week highs that new 52 Week lows at 23 versus 20, respectively. The advance decline line was flat with 1,395 advancing issues and 1,387 declining issues.

Economic and Earnings Calendars

The march numbers for Core PPI and PPI are released tomorrow morning in the pre-market. The expectation is for there to be a slight contraction in PPI and Core PPI from February’s 0.00% and 0.2%, respectively. In addition Retail sales and Business Inventories should provide plenty for market participants to talk and think about. The expectation on these is for Retail Sales to increase 0.3% versus the prior minus 0.1%. Business Inventories for February are expected to decline that same as January’s minus 1.1%. As the graphic illustrates, there are a lot of reports coming out this week so it should be a volatile news driven week.

In addition to the potentially market moving economic reports, there are some larger more influential stocks that are scheduled to report their earnings this week. As for tomorrow, please view the graphic below to see that there aren’t that many that we haven’t already discussed. To repeat, JNJ reports in the morning followed by CSX Corporation, semi conductor stocks Linear Technology (LLTC) and Intel Corporation (INTC) in the after hours tomorrow. The Semi conductors index ($SOX) has advanced 12.9% year to date. I don’t know the other stocks listed that well, but if you do the earnings are here.

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Contrarian Update

Rather than send out a long description of the three indicators, I wanted to include a quick glimpse at the indicator. If you delete the commentary, the basis of using the $VIX is that it is traditionally a long followed contrarian indicator. It is usually looked upon when markets are at their worst and hardly when the markets are advancing to new highs. The media usually doesn’t look for reasons why the market is too high. Therefore, when the $VIX spikes a lot of attention is had. We use the $VIX in a more relative form by providing moving averages and adopting the methodology that the trend of those averages provides the indication to buy or sell the market. The common methodology might make you a hero if you catch the top of volatility buy purchasing long calls and a zero if all of the excess premium erodes faster than the Delta on the calls can generate profits. If you believe in “slow and steady wins the race” then the lethargic 10 and 20 day moving averages can help by determining the overall portfolio bias your positions follow. If the sentiment indicator is advancing upward, it generally suggests you take a short bias because option investors, specifically SPX option traders, on average have determined that the market risk is increasing from before when complacency peaked. The average volatility increases following the peak in complacency while the tendency for the SPX is to decrease when volatility increases. Thus a contrarian indicator that moves inversely.

The trend of the CBOE volatility index ($VIX) is moving downward which indicates a positive bias. We use the 10 (blue line) and the 20 (purple line) to determine the trend of the $VIX. The 10 day moving average closed the day at 40.82 while the 20 day moving average closed at 41.61. With the two averages so close to one another, a move up for a day or two in a row could possibly cause the 10 day moving average (DMA) to cross above the 20 DMA. Now that the $VIX is trading below the 200 day moving average (dashed grey line) the tendency is for the $VIX to bounce up to it and eventually down to the lower Bollinger band. This decline below the 200 day moving average follows a long held high volatility environment not seen in decades. Now that the $VIX is trending down, it is expected to bounce occasionally. The upper level for the $VIX on a market sell off would be the 200 day moving average of 42.42. Before last year, it was unusual to see the $VIX spike above 30 and even less frequent to the 40 level. Volatility as a whole has diminished while the SPX has rallied almost 200 points from the March 6th 667 low. As mentioned last week, the holiday shortened week had drawn the $VIX lower much like we saw near the end of 2008. A move up in the 10 DMA for two consecutive days will place the signal on a Neutral bias.

Technical Review

The chart below shows a 1 minute interval of the S&P 500 (SPX) for today. There are three horizontal lines drawn at gap levels throughout the day. I am one of those traders that believe that all gaps are filled. The close nearly filled in the gap at 858.14 but failed to do so. There are two other levels lower that may be filled in tomorrow or the next day; one at 852.85 and another at 847.51. The two moving averages illustrate the one and two day average price of the SPX. I use it as a visual reference to where the market is in relation to the average price. A trading environment where both the 1 DMA is above the 2 DMA and the price is continually bouncing up from the average prices is one where a trader wants to have a long bias. Today’s chart illustrates that the 1 day is below the 2 day but the SPX was able to hold above the 2 DMA most of the day.

Onto the daily perspective where we look at longer term support and resistance levels to determine our profit and stop targets. For this, we will first look at the SPX chart that shows the longer term moving averages. The SPX was able to shake off last week’s early weakness and get back above the 89 DMA (purple line) at 826. The 50 DMA, currently at 789, stands as my sell off target price, if we ever get one. I do think the SPX will eventually move lower. But I don’t know from what level and when. The market seems to be gravitating toward the 100% retracement from the January and February’s highs the market up. With earnings season and a full week of economic reports, the current consolidation could see some volatility return. The ADX has finally turned up and is indicating that the trend is upward. The confirmation will follow when the ADX closes above 20.

I have drawn a horizontal line at the February highs near 878 to help illustrate where the 100% retracement line is on this chart that uses Bollinger bands and exponential moving averages (EMA). Today’s high reached up to test the upper Bollinger band and then sold off to close slightly higher on the day. Another technical observance that we have been looking for occurred today when the spread between the upper and lower Bollinger bands increased after squeezing together for a couple of weeks. Usually, the increased spread indicates the beginning of a new period of volatility. With the market overbought, as indicated by the RSI and almost the Slow Stochastics, the volatility might have the tendency to be lower after such a strong upward move in just over a month. But I could be wrong on the initial direction.

The lower horizontal line is still indicating that there is a slight gap to be filled in at the 813 level which consequently is the 21 day EMAs current level. But we are still on an uptrend since the 8 is above the 21 day EMA. The strategy is to stay invested in the trend’s direction as long as possible. Remember, buy at tests of the moving average and scale out at over bought levels and closes below the 8 day EMA until it no longer works. When scaling out, the common thought comes from the greed portion of the brain and suggests keeping the entire position to try to benefit from the longer term trend. Some traders/investors do this rather than add risk when the probabilities are in your favor and reduce risk (not necessarily eliminate it altogether) when probabilities suggest reduced potential. Keeping some exposure to the upside is better than all of it to the downside of the trade.