The Wagner Daily | February 19, 2004

Commentary:

The major indices continued their recent pattern of price divergence, but sector rotation enabled relative strength to shift out of the S&P and Dow-related sectors and back into the tech-heavy Nasdaq. The S&P 500 and Dow Jones Industrials both were unable to break above resistance of their respective highs of the previous day, which subsequently caused an afternoon selloff. This means the prior 52-week highs on both indices continued to act as resistance. Conversely, the Nasdaq Composite finally began showing relative strength after breaking above resistance of both its 20-day moving average and the previous day’s high on an intraday basis, but the afternoon selloff in the S&P caused the Nasdaq to give back its earlier gains. Nevertheless, the Nasdaq held up much better than the S&P and Dow, and only closed 0.2% lower than the previous day. This equated to only a one-third retracement of the previous day’s gain. The S&P 500 Index and Dow Jones Industrial Average both showed relative weakness and gave back fifty percent of the previous day’s gains. Both indices closed 0.4% lower. Below is a daily chart of the Nasdaq Composite that illustrates how the index finally popped back above its 20-day MA on an intraday basis, but sold off to close slightly below it:

Although the S&P and Dow both lagged behind the Nasdaq yesterday, total market volume in the NYSE declined by a marginal rate of 1.1%, which is what you want to see on a day when the indices close lower. Volume in the Nasdaq increased by 11% over the previous day, which technically means that yesterday was a “distribution day” in the Nasdaq. However, we are reluctant to view yesterday as a distribution day in the Nasdaq because the loss was so marginal and many leading stocks fared well. Many of the Nasdaq-related sectors also closed flat or even higher on the day. Despite the 11% increase in the Nasdaq’s volume, it still came in below its 50-day average, so it really was not a heavy day of selling.

Based on yesterday’s initial relative strength in the Nasdaq, we recommend watching that index for potential strength over the next several days, especially if the Nasdaq breaks above its Feb. 11 high of 2,089. If it does, odds are good that it will at least attempt a rally back up to test its prior 52-week high at the 2,150 area. One of the key areas that caused the Nasdaq to finally wake up yesterday was the Semiconductor ($SOX) Index, which actually closed with a 0.7% gain yesterday. The $SOX index has been lagging the Nasdaq for the past several months, but it appears we may begin to see sector rotation out of strong “old economy” sectors such as Retail, Banking, and Drugs and back into the Semis. If the $SOX index can break above its key resistance level of 530.48, it should see a multi-day rally. Applied Materials (AMAT) received a positive reception to its earnings report after the close yesterday and is likely to further add to the strength of the $SOX index today. As such, you will notice that we are looking at a potential long play in SMH (Semiconductor HOLDR) in Today’s watch list below. Be aware, however, that the 200-week moving average is likely to act as resistance on the $SOX index at the 545 area. On a different note, keep an eye on the Software Index ($GSO), which has a similar chart pattern to the $SOX daily chart. If the $GSO index clears its February 12 high of 161.10, it could easily rally back up to its prior 52-week high of 165.34. SWH is the HOLDR ETF that tracks the Software Index.

We feel there is a good chance we will see a sharp divergence between the S&P/Dow and the Nasdaq today. From a technical basis, both the S&P and Dow have a lot of overhead supply to contend with due to this week’s failed breakout attempt at the prior 52-week highs. Yesterday’s intraday selloff and relative weakness in both the Dow and S&P adds further price resistance into the mix. However, the strong earnings report from AMAT after yesterday’s close has really gotten the Nasdaq futures and many of the tech stocks excited in the pre-market. If the Nasdaq futures hold on to their pre-market levels, the Nasdaq Composite is going to open above the two-week resistance of 2,089. Conversely, the S&P futures are lagging and still not even bid above yesterday’s intraday high. When the major indices have a sharp divergence such as this, the challenge is that the broad market often trades in a choppy manner because one index acts as a weight, while the other index tries to pull the lagging index higher. To put the odds in your favor and reduce your overall risk today, consider being long the tech-related sector ETFs and stocks, while simultaneously being short the Dow and the “old economy” sectors and stocks that show relative weakness today. We intend to do the same, as we are currently short DIA (Dow Jones), but are also looking to buy SMH (Semiconductor HOLDR). Just use caution because we have seen this divergence many times before and it is rarely easy to ride out trends on EITHER side of the market.

Today’s watch list:

SMH – Semiconductor HOLDR
Long

Trigger = above 43.45
(above the Feb. 12 high)
Target = 44.80 (resistance of Jan. 22 high)

Stop = 42.90 (below yesterday’s high)

Notes = We are looking to buy a breakout in the Semiconductor Index, which began showing strength yesterday. However, since SMH is likely to gap up above its trigger price, remember to use the MTG Opening Gap Rules, which means we will only buy SMH on a break above its 20-minute high.

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 = + $30

IWM short (from Feb. 18) –
shorted 117.97, new stop 118.90, unrealized points = + 0.14, unrealized P/L = + $14

Notes:

Per intraday e-mail alert, we added to the DIA short yesterday, and also shorted IWM when it broke below 118. Since we have a large opening gap up today, remember to use the MTG Opening Gap Rules, which means we will wait for a break of the 20-minute high before stopping out of any ETF that gaps up above our stop.

Edited by
Deron Wagner,
MTG
Founder and President