The Wagner Daily | March 8, 2006

Commentary:

Yesterday was a session of broad market divergence, as small and mid-cap stocks sold off sharply, but the blue chips of the Dow eked out a nominal gain. The small-cap Russell 2000 and S&P Midcap 400 indices both drifted lower throughout the day and sustained losses of 1.4% and 1.2% respectively, while the Nasdaq Composite slid 0.8%. Confined buying interest in the final thirty minutes helped lift the S&P 500 off its lows and minimize its loss to only 0.2%. The Dow Jones Industrial Average was the only index that closed higher, managing a 0.2% gain.

Total volume in the NYSE declined by 2% yesterday, while volume in the Nasdaq was 11% lighter than the previous day’s level. The fact that yesterday’s losses occurred on lower volume could be construed as a positive, but remember that three “distribution days” in both the S&P and Nasdaq have already occurred within the past week. Despite the decrease in turnover, market internals were firmly negative. Declining volume in the NYSE exceeded advancing volume by a margin of 5 to 2, while the Nasdaq’s ratio was worse at nearly 7 to 2. This tells us that even though stocks may not have sold off on heavy volume, overall volume was a lot heavier on the downside than the upside.

After the close of trading, we noticed that many of the popular financial web sites were saying it was positive that the Dow bucked the trend and closed higher yesterday. This, of course, is not surprising because the financial press always has a tendency to portray a positive slant to each day’s action, regardless of the actual outcome. The reality, however, is that yesterday was pretty nasty overall. The biggest concern was the major relative weakness in nearly all the market leading stocks. Although the giant blue chip corporations such as Intel, Wal-mart, Microsoft, and Pfizer have huge market caps, they are no longer considered to be “market leaders” because their aggressive growth years have passed long ago. Instead, the performance of today’s market leading stocks such as Marvell Technology, Google, Hansen Natural, and SanDisk is much more an indicator of the market’s health. This is so because the direction of aggressive growth stocks historically tends to lead the market in both bull and bear markets. When many market leading stocks are registering huge gains and consistently climbing to new highs, the broad market tends to follow. Conversely, the broad market often drops sharply after the market leaders begin to fall apart. Unfortunately for the bulls, the latter scenario is what we see happening right now.

In addition to weakness among market leading stocks, we have also lost leadership among the semiconductor sector. When the former market leading sectors such as oil, gold, and utilities began to correct earlier this year, new leadership soon followed with strength in the semiconductor and computer networking sectors. However, the Semiconductor Index ($SOX) has fallen 6% over the past three days. More importantly, the $SOX closed yesterday below its 50-day moving average for the first time since last November. Obviously, the $SOX has quickly lost its former relative strength as well. Therefore, unless new sector leadership soon emerges, we don’t expect much broad-based strength.

Because market leading stocks are often in the “mid-cap” category, the cumulative performance of that group is often represented by the S&P Midcap 400 Index. Similarly, the small-cap Russell 2000 Index has been a market leader for the past several years and is presently a more accurate barometer of the broad market’s health than the Nasdaq Composite. This is the reason we always report on the daily performance of both the Russell 2000 and S&P 400, even though the general financial media tends to ignore these two very important market indices. If you look at yesterday’s performance in MDY, the popular ETF that tracks the S&P 400, you will understand why we feel the broad market may be in for a substantial correction:

As you can see, MDY broke support of its steady 5-month uptrend line and finished below its 50-day moving average for the first time since the primary uptrend began back in October 2005. IWM (iShares Russell 2000) is still above its 50-day MA, but broke support of a three-week band of consolidation. As such, we would not be surprised to see IWM follow MDY in breaking its 50-day MA in the coming days. If you are looking for a new short entry in one of the broad-based ETFs, you may want to consider either MDY or IWM. We shorted MDY on February 21 when it formed the right shoulder of a bearish “head and shoulders” pattern, but we were a bit too early and stopped out on February 27. Nevertheless, a re-entry in MDY short is now much lower risk because it has confirmed its initial signs of weakness by falling below its 50-day MA and primary uptrend line. As long as MDY stays below its former uptrend line, which is now the new resistance level, we view any intraday bounce as a chance to sell short into strength.

As for the S&P 500, it is now sitting at a crossroad and traders will be forced to decide whether the index “makes it or breaks it” from here:

After probing below its 50-day MA yesterday afternoon, notice how the index recovered into the close and finished right on the 50-MA. It’s also interesting to note that yesterday’s low coincided with support of the daily uptrend line as well. Therefore, the S&P 500 should either fall apart from here or reverse off support of the uptrend line and 50-day MA. In addition to weakness in the market leaders that we discussed above, it is bearish that the S&P recently failed to breakout from its consolidation at its prior 52-week high. Instead, it fell back down to its 50-day MA after trading above it for only three weeks, leaving a potential “double top” formation on the daily chart. Now if we knew for certain whether the S&P will collapse below support or reverse and rally off its 50-MA, we would be billionaires by now. We can, however, increase our odds of being on the right side of the market by taking an objective look at all the technical aspects of the current market environment. In doing so, we certainly feel that overall odds favor the short side of the markets.

Today’s Watchlist:

There are no new setups for today, as we are near our maximum buying power of the model account. We may, however, lighten up on the share size of SPY if it does not close below its 50-day moving average today. Doing so would enable us to short weaker ETFs instead.

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 = + $642

Closed positions (since last report):

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

$76,782

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