The Wagner Daily


Stocks shook off mid-day weakness to close mixed yesterday, at least temporarily putting the brakes on the broad market’s recent slide. The S&P 500 and Dow Jones Industrial Average, both down approximately 0.5% at their intraday lows, closed higher by 0.3% and 0.4% respectively. The Nasdaq Composite finished lower for the fifth consecutive day, but only by 0.2%. Small and mid-cap stocks continued to show major relative weakness, as both the Russell 2000 and S&P Midcap 400 indices lost 0.6%. The small-cap Russell 2000 has lost nearly 5% in just the past three days, but this is not surprising because it is also the index that showed the most relative strength when the market was bullish.

Total volume in the Nasdaq was 12% lighter than the previous day’s level, indicating that institutions took a break from the recent distribution of stock. Volume in the NYSE was about the same as the prior day. Despite lower turnover in the Nasdaq, market internals were still negative. Declining volume in that exchange exceeded advancing volume by more than 2 to 1. Regardless of a slightly higher closing price in the S&P, the NYSE internals were negative as well. Declining volume was heavier than advancing volume in the NYSE by a margin of just under 3 to 2.

When a strong, uptrending market corrects sharply off its highs, the industry sectors that were previously showing the most relative strength are often the ones that correct the largest percentage. At the same time, institutional money flow out of those sectors often goes directly into some of the formerly “beaten down” industries that lagged when the broad market was strong. Although the market has lacked clear sector leadership since the broad market selloff began on May 11, we have begun to see moderate signs of institutional sector rotation that has led to pockets of industry strength.

Oil, Gold, and Metals, three industry sectors that have been outperforming the broad market for many months, have each corrected sharply over the past several days. Since May 10, the S&P 500 has lost 2.1%, but the Oil Index ($XOI) has slid 5.4% during the same period. We covered half of our short position in the S&P Energy Sector (XLE) for a 5% gain yesterday. The Gold Index ($GOX) has plummeted a whopping 12.6% over the past three days! Because institutions such as mutual funds typically have bylaws that dictate they must be fully invested in the market at all times, where has all of the institutional outflow of these sectors gone? The answer may lie in the healthcare-related sectors, which began to show pretty decent strength yesterday. The S&P Select Health Care SPDR (XLV) outperformed with a 1.4% gain yesterday, the Pharmaceutical HOLDR gained 1.8%, and the Biotech HOLDR (BBH) advanced 1.9% (reference the Morpheus ETF Roundup for a list of other ETFs in the same sector). Of these three, BBH is the only one that is nearing a clear technical entry level on the long side. Although it has been in a steady downtrend since November of 2005, it appears that BBH is trying to put in at least a short-term bottom:

While the broad market has steadily dropped over the past three days, BBH has traded sideways to higher. The Nasdaq Composite has lost 3.5% over the past three days, but BBH has gained nearly 1% during that same period. As such, it can be said that BBH (and the biotech stocks in general) have begun to show relative strength. We obviously don’t know how long the relative strength will last, but sectors that are outpeforming the broad market are always the safest ones to be long in a weak market. If the market continues lower, BBH is likely to fall less than other sector ETFs. Conversely, it should be among the first sectors to rally when the broad market bounces. As regular subscribers will note below, we are looking to buy BBH on a rally above its May 9 high. We are also stalking a couple of weak sectors for short selling opportunities, but are patiently awaiting the proper entry point to sell short on a bounce into resistance. If stocks bounce today, we will highlight a few sectors we like on the short side in tomorrow’s Wagner Daily.

As mentioned yesterday, we feel that short selling should now be concentrated in the S&P and Dow-related sectors due to the Nasdaq trading near major support levels. Specifically, the Nasdaq closed right at its 200-day moving average yesterday and is still holding support of its 2006 low, albeit not by a wide margin. The best looking broad-based ETFs for short selling are the Russell 2000 (IWM) and the S&P Midcap 400 (MDY), although we would ideally like to see a bounce in both of those today before entering a new short position in either one. A retracement back up to the 50-day MA in IWM would present an ideal risk/reward level for short entry.

Today’s Watchlist:

BBH – Biotech HOLDR

Trigger = above 177.27 (above May 9 high)
Target = 186.20 (resistance of 200-day MA)

Stop = 172.55 (below yesterday’s low)
Shares = 100

Notes = Note that we are not anticipating a complete reversal of the 6-month downtrend in BBH. Rather, we are playing a technical bounce up to resistance of its 200-day moving average. Because we are in a weak overall market, notice that we have also reduced our risk exposure on the long side by trading only 100 shares based on the model account (less than $500 risk). Separately, we are stalking a few ETFs such as IWM for potential entry on the short side, but we want to see the extent of their upside corrections first.

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):

      XLE short (200 shares from May 3 entry) –
      sold short 58.66, stop 58.65, target 54.05, unrealized points = + 3.11, unrealized P/L = + $622

    Closed positions (since last report):

      XLE short (200 shares from May 3 entry) –
      sold short 58.66, covered 55.73, points = + 2.93, net P/L = + $582

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



      Per intraday e-mail alert, we covered HALF of our short position in XLE for a 5% gain yesterday. We remain short the second half of the position with a tightened stop at breakeven. Target on second half remains 54.05.

    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