The Wagner Daily | January 7, 2004

Commentary:

The major indices spent most of yesterday in a tight and narrow range, consolidating near the previous day’s highs, until a modest wave of buyers pushed both the S&P 500 and Nasdaq Composite to new highs during the final hour of trading. The Nasdaq once again showed relative strength to the S&P, despite weakness in the Biotechs. The Dow began showing signs of weakness yesterday and was the only one of the major indices that closed (fractionally) lower on the day. As analyzed in yesterday morning’s newsletter, we initiated a partial short position in DIA (Dow Jones Indu.) due to resistance of the monthly downtrend line from the January 2000 high. The S&P 500 ended the day one point higher, while the Dow Jones closed five points lower. The Nasdaq Composite closed ten points higher for a gain of + 0.5%. Overall, there were limited opportunities for intraday trading yesterday due to the narrow range and choppy action in the S&P and Nasdaq futures markets. As such, we preserved capital and remained mostly in SOH (Sitting On Hands) mode in the Intraday Real-Time Room.

Total market volume yesterday came in about 3% below the previous day, but was still well above average levels. However, since the broad market turned in a mixed performance, there may have been some distribution taking place as the market had the feeling of some churning. The volume breadth confirmed that feeling because advancing volume outpaced declining volume by a margin of only 1.12 to 1 yesterday in the NYSE and 1.74 to 1 in the Nasdaq. This leads us to believe that the market may be headed for a correction in the short term, which would not be surprising given how overextended the major indices have gotten away from their 20-day moving averages.

Software (SWH)and Internet (HHH) HOLDRS, both of which closed at new highs, were the strongest sector ETFs within the Nasdaq. Retail (RTH), Financial (XLF), and Telecom (TTH) sector ETFs showed the most relative strength in the S&P yesterday. Gold Mining stocks took a breather yesterday, as did Utilities, both of which have been market-leading sectors recently. The Home Builder sector, which we profited from on the short side over the past week, bounced a bit yesterday and now has overhead resistance of its 20 and 50-day moving averages. The head and shoulders pattern on the sector is still intact and the next major move will probably result in a break below the neckline. Below is an updated daily chart of the U.S. Home Builder Index ($DJUSHB) that illustrates the head and shoulders pattern and the potential re-entry point on the short side:

As we have stated in the past, there is not an ETF that tracks this index, but you may wish to create your own synthetic ETF by trading a small basket of the leading stocks such as RYL, LEN, TOL, DHI, HOV, CTX, KBH, and BZH. When selecting which stocks to potentially short, those that are below both their 20 and 50-day moving averages would probably provide the best risk/reward ratios.

Two additional ETFs we want to bring to your attention are EWJ (Japan Fund) and EWH (Hong Kong Fund). As long-time subscribers to The Wagner Daily will recall, we have been bullish on the prospects of Asia for the past year and have profited handsomely from several long entries in EWJ over the past 9 months. In order to minimize risk and maximize gains, we have been buying EWJ on each pullback to support and selling several weeks later on a move into resistance. However, both EWJ and EWH have now broken out to new 52-week highs and have the potential to run sharply higher IF they hold at their new highs. We will be watching for a potential long entry in both of these ETFs in the coming days. Below are weekly charts of both EWJ and EWH that illustrate this week’s breakout to new highs. Notice also how EWJ has just broken through its 200-week moving average, which is always a significant resistance level in any index:

It is a bit tricky to profitably trade the broad-market ETFs such as SPY or QQQ right now because the major indices have not yet given us any clear signals to sell short, but entering new long positions at current overbought levels is just as risky. Instead, consider trading specific sector ETFs, such as we have done with OIH this week, because individual sectors can maintain their trends easier when they show relative strength or weakness to the broad market. If you are presently in long positions, we strongly recommend using tight stops to protect gains in the event of a market correction, which we feel could easily happen at any time. If you’re short, you may want to be a little patient here, but don’t let positions get away from you either because overbought markets can remain that way for many days.

The most important thing to be aware of right now is the fact that earnings season will begin next week. Given the broad market’s strong gains over the past month, positive earnings expectations are probably already priced into the market. Therefore, positive earnings reports are not likely to give the market much of a boost, while any perception of less than stellar earnings, especially any warnings, are likely to cause some selling. We’ll continue tracking the relationship between volume and price in order to better gauge the direction of the market’s next major move.

Today’s watch list:

IWM – iShares Russell 2000 Small Cap Index
Short

Trigger = below 112.85
(below both yesterday’s close and the prior high from Dec. 31)
Target = 109.60 (support of the 20-day moving average)

Stop = 114.25 (above yesterday’s high)

Notes = IWM closed very weak yesterday because it sold off during the final fifteen minutes of trading. This has caused a bearish “inverted hammer” candlestick formation on the daily chart, which we believe will lead to a multi-day correction in the small caps and IWM. We’re just looking to short the correction down to the 20-day MA.

Daily Reality Report:

Below is Morpheus Trading Group’s daily
performance report of closed trades and an update on all open positions from The
Wagner Daily (Intraday Real-Time Room trades are reported separately in The
Wagner Weekly). Net P/L figures are based on the quantity of shares represented
in the MTG
Position Sizing Model.

Closed Positions:

(none)

Open Positions:

unrealized P/L = + $27

DIA short (HALF position, from Jan. 6) –
shorted 105.20, stop 107.55, target 100.50, unrealized points = (0.30), unrealized P/L = ($30)

Notes:

We have lowered the stop in OIH to just below the 20-day moving average, which also corresponds with a break of the current consolidation. Per yesterday’s newsletter, we also shorted a HALF position of DIA. Remember the expected time horizon of the DIA trade is one to two months.

Edited by
Deron Wagner,
MTG
Founder and President