The Wagner Daily | February 5, 2004

Commentary:

After beginning the day with a sharp opening gap down, the S&P 500 and Dow Jones Industrial Average both rallied and “filled the gap” during the morning session. However, both the Nasdaq Composite and Russell 2000 Small Cap Index showed relative weakness and were unable to rally in sync with the S&P and Dow. This divergence eventually caused the S&P and Dow to lose their early strength and, along with the Nasdaq, sell off to new intraday lows around 2:00 pm EST. The late afternoon selloff created additional overhead price resistance that caused the Nasdaq to close at its lows of the day, although both the S&P and Dow closed slightly off their lows. Of the major indices, the Russell 2000 Small Cap Index sustained the largest loss, 2.6%, which benefitted our short position in IWM. The Nasdaq Composite performed similar to the Small Cap Index and lost 2.5% of its value. The Dow Jones showed the most relative strength and only closed 0.3% lower, while the S&P 500 dropped 0.8%.

Volume was 11% higher in the NYSE and a significant 23% higher in the Nasdaq. Since both the S&P and Nasdaq closed with losses, yesterday was another confirmed “distribution day.” Within the past seven trading days, there have been a total of three distribution days in the NYSE and five in the Nasdaq (although one of those days barely qualified as a distribution day). As we have said in the past, one or two distribution days over the course of a week can usually be absorbed in a healthy bull market. However, when you start seeing three to five days of institutional selling within a period of several weeks, it is often enough to begin a moderate correction in a bull market. Many bear markets have started with a series of numerous distribution days after an overextended bull market. Just to clarify, we are certainly NOT forecasting the beginning of a bear market, but are merely reiterating the importance of tracking institutional selling when it comes to assessing the overall health of a bull market. If the market begins to recover AND volume increases on the way back up, this would be a positive sign for the markets. But, if we continue to see more distribution days over the next week, I would be very cautious about buying any pullbacks because they could fail.

Yesterday’s selloff caused the Nasdaq Composite Index to close below its 50-day moving average for the first time since December 17. However, the Nasdaq only closed 3 points below it, so we can not yet label this a “confirmed break” of the 50-day MA. The Nasdaq has bounced off support of its 50-day MA at least six times since the primary uptrend began last March. The daily chart of the Nasdaq Composite below illustrates this:

Looking at the chart above, the blue line illustrates support of the primary uptrend from the lows of March 2003. This uptrend line converges with support of the 50-day MA. The Russell 2000 Small Cap Index also closed at its 50-day MA. Only time will tell if the 50-day MA and primary uptrend line once again acts as support for the Nasdaq, but, for what it’s worth, the number of recent distribution days on this last selloff has been higher than during any other correction since last March.

Unlike the Nasdaq and Russell, both the S&P and Dow are still holding well above their 50-day MAs, although both indices closed firmly below their 20-day MAs yesterday. The S&P’s 200-week moving average, which we have been closely watching over the past several weeks, acted as support yesterday. Going into yesterday, the 200-week MA was at 1123.5 and yesterday’s low on the S&P 500 was 1124.74. So, you can see that the 200-week MA is a key level to continue watching for the remainder of the week.

We made the decision to cover half the position size of our SPY and DIA shorts yesterday morning due to the relative strength that both indices were exhibiting. At the time we sent the intraday e-mail update, both the Dow Jones and S&P 500 had recovered all their losses from the morning gap down and were consolidating at their intraday highs. Furthermore, the Dow had broken above resistance of its hourly downtrend line from the high of Jan. 26. These two factors caused us to think that we would subsequently see a sharp reversal in the broad market, so we made a judgement call to lock in profits on partial share size of our short positions. Obviously, the consolidation and break of the hourly downtrend line failed in the afternoon, but the decision made sense given the market conditions. When unsure, it is usually a good idea to lock in profits on partial position size rather than risking a winning trade turning into a loser. We did, however, remain short the full position of IWM yesterday because that index was clearly weaker than both the S&P and Dow.

Going into today, we expect to see some major sector rotation. The Nasdaq has sold off well ahead of both the S&P and Dow over the past week and has now reached a key support level of its 50-day MA. Conversely, both the S&P 500 and Dow Jones are only now beginning to show moderate weakness. Therefore, we expect to see some buying interest in heavily sold sectors such as Semiconductors ($SOX), Mining Stocks ($XAU), and Internets ($GIN), while we may begin to see weakness in other sectors that have been showing relative strength to the markets. Two sectors we are stalking on the short side are Banking ($BKX) and Broker-Dealers ($XBD), both of which broke their 20-day moving averages yesterday. The Broker-Dealer sector in particular looks pretty compelling for a short right here. The index dropped to support of its 20-day MA last week, barely retraced any of the selloff, then dropped firmly below the 20-day MA yesterday. We now expect the index to correct down to its 50-day MA. Here is a daily chart of that index:

There is not an ETF that tracks the broker-dealer index, but you may consider making your own synthetic ETF by trading a basket of the leading stocks within the index. Individual names to consider shorting are: LEH, BSC, GS, MWD, and MER.

Today’s watch list:

Since we currently have three open positions, there are no new plays for today. However, as suggested above, you may consider shorting the banks or broker-dealers. XLF is an ETF that covers a broad range of financial stocks.

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:

unrealized P/L = + $84

DIA short (HALF position, from Jan. 6 and Jan. 9) –
shorted 105.27 (avg.), covered 105.14, points = + 0.13, net P/L = + $24

Open Positions:

unrealized P/L = + $178

SPY short (HALF position, from Feb. 2) –
shorted 114.32, new stop 114.15, target 110.60, unrealized points = + 1.47, unrealized P/L = + $147

DIA short (HALF position, from Jan. 6 and Jan. 9) –
shorted 105.27 (avg.), new stop 105.95, target 100.50, unrealized points = + 0.49, unrealized P/L = + $49

Notes:

We shorted IWM after it broke its 20-minute low, per yesterday’s newsletter. We also covered half our share size in both SPY and DIA and have adjusted the stops as per above.

Edited by
Deron Wagner,
MTG
Founder and President