The Wagner Daily | May 16, 2005

Commentary:

The broad market divergence that we discussed in the May 13 Wagner Daily intensified even more last Friday. Strength in the tech stocks, including a 2.8% gain in the Semiconductor Index, enabled the Nasdaq Composite to move 0.7% higher. Both the S&P 500 and Dow Jones Industrial Average, however, closed the day 0.5% lower. As is often the case on days of big divergence, intraday price action of the major indices was quite volatile. The Nasdaq traded as much as 1.3% higher in the morning, sold off all the way down to near unchanged, then recovered to gain 0.7% into the close. The other major indices spent the first few hours in marginal positive territory, then spent the remainder of the day in the red.

Since the inception of this newsletter three years ago, last Friday was the first time we recall ever seeing a confirmed “accumulation day” in one index, but a “distribution day” in another. Total volume in the Nasdaq increased by 5% last Friday which, along with the 0.7% gain, made it a confirmed day of institutional accumulation. However, volume in the NYSE similarly increased by 9%, but both the S&P and Dow closed solidly in negative territory. This means it was a confirmed day of institutional distribution in the S&P and Dow. If one index closes higher and on higher volume (aka “accumulation”), the other index will usually show decreasing volume if it closes negative on the day. Conversely, if one index closes lower and on higher volume (aka “distribution”), any other index that happens to close higher will usually have done so on lighter volume. But it’s very uncommon to have one exchange close with a decent gain, the other exchange close with a solid loss, but both exchanges doing so on higher volume.

Fortunately, the broad market divergence that began on May 12 prepared us for further divergence the following day. Nevertheless, the substantial divergence now makes it difficult to determine which side of the broad market to be positioned on. If you position yourself exclusively on the long side of the Nasdaq, you are taking the risk that weakness in the S&P and Dow will drag your positions lower. On the other hand, short positions in the S&P and Dow may not work due to the fact that the Nasdaq often leads the direction of the entire broad market. Therefore, your best option is probably to remain positioned on the long side of sectors that are showing relative strength and on the short side of those sectors with relative weakness.

As for which sectors are now showing the most relative strength and weakness, look to the same industries in which we discussed weakness and strength in the May 13 issue of The Wagner Daily. On the long side, the tech-related sectors are obviously the place to be. The Semiconductor Index ($SOX) closed above its 200-day MA for the first time since April 12. SMH, the corresponding ETF, is now approaching the resistance level of a downtrend that has been in place for nearly 18 months. If it breaks out above that, the Semis are likely to develop some sustainable upside momentum. The weekly chart of SMH below illustrates this:

As for weak sectors, it seems that the former market leaders of the past six months to a year are now beginning to show major relative weakness due to sector rotation. These sectors include: Oil, Oil Service, Utilities, Financial, Home Construction, and Retail. The Dow Jones Utility Average ($DJU), for example, broke below its primary uptrend line and closed below its 50-day moving average for the first time since January of 2005. The amount of overhead supply in that sector now makes the Utility stocks prime candidates for shorting. As you know, we shorted UTH (Utilities HOLDR) when it broke support on Friday. The daily chart below illustrates the break of support in the $DJU:

Overall, use caution in the broad market until it resolves itself one way or the other. Markets in which the major indices are diverging sharply can be very whippy and volatile.

Today’s Watchlist:

There are no new trade setups for today because we currently have three open ETF positions (short DIA, XLF, and UTH)

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 = + $300

XLF short (from May 12) –
shorted 28.63, stop 29.28, target 27.10, unrealized points = + 0.40, unrealized P/L = + $240

UTH short (from May 13) –
shorted 103.64, stop 105.60, target 99.10, unrealized points = + 1.57, unrealized P/L = + $157

Notes:

UTH short triggered per yesterday’s newsletter. No changes to stops on open positions.

Edited by Deron Wagner,
MTG Founder and
President