The Wagner Daily


Broad divergence was the operative word to describe yesterday’s market action, as the Nasdaq Composite showed strength and closed 0.4% higher, while the Dow Jones Industrial Average was quite weak and closed 0.7% lower. The broad-based S&P 500 Index showed a mixed performance and closed basically flat (0.1% lower). Both the S&P and Nasdaq once again spent most of the day in a narrow, choppy range that made it challenging to profit from intraday trading of the broad-based ETFs. Total market volume registered nearly the same levels as the previous day in both the NYSE and Nasdaq. Despite the broad market’s mixed performance, advancing volume outpaced declining volume by a healthy margin in both the NYSE and Nasdaq.

Yesterday’s strength in the Nasdaq came mostly from small cap stocks within the Software ($GSO), Hardware ($HWI), and Telecom ($XTC) sectors. The more heavily weighted Semiconductor ($SOX) and Biotech ($BTK) indexes consolidated and digested the previous day’s gains. The Dow’s losses were due to a “sell the news” reaction from quarterly earnings reports of several blue chip companies. 3M (MMM) lost nearly 6% yesterday, despite the fact they beat earnings consensus by a penny. Similarly, United Technologies (UTX) dropped 2.7% yesterday after they beat earnings expectations by 3 cents per share. Honeywell (HON) lost 4.7% and Caterpillar (CAT) dropped more than 2% yesterday as well. We don’t frequently discuss the performance of individual stocks in this newsletter because its focus is on exchange traded funds. However, yesterday’s weak performance by some of the leading blue chips is significant because it tells us that strong earnings expectations were already built into the prices of the recent rally in the Dow stocks. As we mentioned before the start of earnings season two weeks ago, it is not the actual earnings reports that matter, but how the stock prices react to those reports. With the exception of IBM, we have been seeing a mostly negative reaction to quarterly reports. This means the market would need a new impetus in order to keep stock prices propped up at the current levels without any type of correction. Because of the bearish reaction to several of the blue chips yesterday, we are beginning to feel more confident the major indices will see a moderate correction after earnings reports have concluded.

Yesterday morning, the Dow Jones Industrial Average gapped up to open above the previous day’s high, but trended lower all day and closed below the previous day’s low. When an index opens above its previous day’s high, but closes below the previous day’s low, this price action causes a “bearish engulfing” candlestick pattern to be formed, which is what occured on the daily chart of the Dow yesterday. While this type of candlestick pattern frequently marks a short-term top and leads to lower prices in subsequent days, it is important to realize that the Dow formed a similar pattern on January 9, but failed to follow-through to the downside. The difference this time, however, is that a double top has also formed on the daily chart of the Dow, which is annotated below:

As illustrated yesterday, the primary, multi-year downtrend of the Dow is still intact, so we will remain short the position in DIA (Dow Jones Industrial Average) in anticipation of further correction. At the very least, we anitipcate a re-test of the 20-day moving average, which is currently at 10,456 for the Dow and 104.72 for DIA.

On a different note, let’s revisit the subject of gold and silver prices. As most of you know, I have personally been bullish on not only gold and silver mining stocks over the past several months, but also gold and silver bullion itself. In case you are not aware, Gold futures corrected last week from a high of $428, down to $407 per ounce, before finding support just above its 50-day MA and bouncing to close over $412 yesterday. Given the large gains in spot gold, the correction was not surprising and was actually healthy for the precious metals markets. While gold was correcting last week, I noticed that the Silver futures were NOT correcting at nearly the same percentage basis as gold. Upon further examination of the two charts, I also noticed that Silver had rallied a much higher percentage than Gold during the metals’ most recent upward move. This means that Silver, which traders seemingly had forgotten about, has begun to show relative strength to the price of Gold.

One clear example of the relative strength of silver can be found by taking the spot price of gold and dividing it by the price of silver. If you did this calculation on December 1 of 2003, one ounce of gold would have bought you 73.8 ounces of silver ($403.80 divided by $5.47). But, based on the price relationship of gold and silver on December 31, that same ounce of gold would only buy you 69.6 ounces of silver ($416.10 divided by $5.96). To put these numbers in perspective, consider the price relationship between the two metals during their major bull peak in January of 1980. As of January 31, 1980, gold futures were trading at a whopping $1,297 per ounce and silver was trading at $49 per ounce, meaning the gold/silver ratio was only at 26. While I am not implying that the ratio will drop that low, it is something to think about. According to my rough estimation, the historical relationship between gold and silver is somewhere in the 40s. As of yesterday’s close, which factors in last week’s price correction in both markets, the ratio is now down to 65.3 ounces of silver per ounce of gold.

Even though you probably don’t trade gold and silver futures, this divergence is important to know because it tells us that the risk/reward of trading the mining stocks may favor those that concentrate on silver mining rather than gold mining, at least in the short-term. Instead of stocks like NEM, PDG, and ABX, you may want to research and consider silver mining stocks such as CDE, SSRI, and SIL, just to name a few. We bought CDE for a swing trade in the Intraday Real-Time Room yesterday and have a small unrealized gain in the position thus far. I have also personally bought more silver coins and bullion, while keeping my gold investment at the same level. Take this analysis for what it’s worth; hopefully some of you may benefit.

The market will be digesting the President’s State of the Union address last night, so it could be choppy yet again. The earnings season continues as well and we don’t anticipate any major moves in the market until earnings have all been brought to light. Based on yesterday’s action, odds favor weakness in the large caps and relative strength in the small to mid-caps. But, this divergence has been constantly shifting around, so don’t bank on it. We continue to maintain a cautiously bearish stance on the short-term of the market, but want to see more confirmation of a top before entering more short positions.

Today’s watch list:

(There are no new plays for today. Instead, we will focus on micromanaging the two open positions below.)

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:


Open Positions:

    HHH short (from Jan. 16) –
    shorted 52.75, stop 53.70, target 50.60, unrealized points = (0.35), unrealized P/L = ($35)

    DIA short (full position, from Jan. 6 and Jan. 9) –
    shorted 105.27 (avg.), stop 107.55, target 100.50, unrealized points = (0.19), unrealized P/L = ($38)


Since EWH gapped up above its trigger price, but then trended lower, we did not buy it yesterday. The MTG Opening Gap Rules prevented us from buying the gap up.

We inadvertently failed to list the HHH short in yesterday’s newsletter, but we are still short from last Friday. Stop and target on HHH listed above. We also remain short DIA, which again showed weakness yesterday.

Edited by
Deron Wagner,
Founder and President