The Wagner Daily | October 5, 2005

Commentary:

The broad market feebly attempted to rally throughout the first half of yesterday’s session, but the bears handily took control in the afternoon, causing each of the major indices to close sharply lower and on higher volume. The S&P 500 shed 1.0%, the Dow Jones Industrials lost 0.9%, and the Nasdaq Composite fell 0.8%. Small and midcap stocks exhibited relative weakness, as the Russell 2000 and S&P 400 indices both lost 1.0%. Each of the major indices closed at their intraday lows, setting the tone for opening weakness in today’s session.

Yesterday’s losses were significant because they corresponded with a rise in total market volume. Volume in the NYSE increased by 13%, while volume in the Nasdaq was 10% higher than the previous day’s level. The losses on higher volume caused both the S&P and Nasdaq to clearly register another bearish “distribution day,” a clear sign of institutional selling. It was the fourth day of higher volume losses in the Nasdaq within the past month. The S&P has had five “distribution days” during the same period. Market internals in the NYSE were positive throughout most of the day, but turned quite negative during the last ninety minutes of trading. Declining volume exceeded advancing volume by a margin of 2.7 to 1 in the NYSE, but the ratio was only slightly negative in the Nasdaq.

In yesterday’s Wagner Daily, we pointed out how a plethora of broad market indices and industry sectors had rallied up to resistance of their downtrend lines that have been in place for the past one to two months. As if right on cue, many of these sectors and indices reversed yesterday and appear to be resuming their existing downtrends. Among many others, one sector that reversed after perfectly running into its downtrend line was the Home Construction Index ($DJUSHB), which the Morpheus Capital hedge fund has been swinging on the short side for the past several months:

As you can see on the chart above, $DJUSHB has been in a downtrend since the end of July. The index formed a short-term double bottom in the second half of September and tried to rally just above support of its 200-day MA. However, overhead resistance of the 20 and 50-day MAs, as well as the downtrend line, prevented the rally from making headway. After hitting resistance of its downtrend line, the index got slammed and plummeted 4.2% yesterday. Due to this relative weakness, we now expect the index to break support of its September low, which would also result in a fall below the 200-day moving average. Such an occurrence would also result in a clear break of the weekly uptrend that has been in place for the past several years. It seems the party may be over for the huge gains in the home construction stocks.

There is not an ETF that specifically tracks the home construction sector, but you may wish to build your own “synthetic” ETF by shorting a basket of several leading stocks within the index. In no particular order, some stocks to consider are: KBH, RYL, LEN, PHM, DHI, HOV, TOL, BZH, and WCI. You will notice that each of them have similar chart patterns. You may also want to keep an eye on IYR and ICF, two exchange traded funds that track Real Estate Index Trusts (REITs). Although not directly tied to the home construction sector, the REITs are rolling over as well. We netted a multi-point gain on IYR last month and may consider reshorting if it breaks support again.

Because each of the major indices demonstrated similar weakness yesterday, it seems likely that the broad market will re-test its prior lows over the next one to two weeks. To profit from this, you may also wish to consider shorting one or several of the broad-based ETFs such as SPY, QQQQ, DIA, IWM, or MDY. If unsure which one to short, your best bet is to short the one showing the most relative weakness to the other indices. As regular subscribers already know, we chose to enter a new short position in IWM (iShares Russell 2000 Index) yesterday because it recovered the least of the major indices during the past week’s rally. When a sector or index lags behind on the way up, it is typically the one that will fall the hardest on the way down. As such, we anticipate IWM outpacing the broad market on the downside if the weakness continues.

Today’s Watchlist:

There are no new plays for today, as we are near our maximum buying power based on the $50,000 model account size.

Daily Performance Report:

Below is an overview of all open positions, as well as a performance report on all positions that were closed only since the previous day’s newsletter. Net P/L figures are based on the $50,000 Wagner Daily model account size. Changes to open positions since the previous report are listed in red text below:

Open positions (coming into today):

, unrealized P/L = + $1,116

IWM short (500 shares from Oct. 4 entry) –
shorted 66.43, stop 67.30, target 63.20, unrealized points = + 0.65, unrealized P/L = + $325

FXI long (400 shares from Oct. 3 entry) –
bought 64.61 (avg.), stop 62.80, target new high (will trail a stop), unrealized points = (1.01), unrealized P/L = ($404)

Closed positions (since last report):

Current equity exposure ($100,000 max. buying power):

$86,200

Notes:

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here for glossary and explanation of terms used in The Wagner Daily

Click here to view MTG’s past performance results (updated monthly).

Edited by Deron Wagner,
MTG Founder and
Head Trader