The Wagner Daily | August 17, 2006

Commentary:

For the second consecutive day, the major indices gapped higher on the open, trended upwards throughout the session, then finished near their intraday highs. The Nasdaq Composite rallied 1.6%, the S&P 500 0.8%, and the Dow Jones Industrial Average 0.9%. Both the small-cap Russell 2000 and S&P Midcap 400 indices gained 1.4%. Because the S&P closed at a new three-month high, our position in the UltraShort S&P 500 ProShares (SDS) was stopped out, but our long position in the Pharmaceutical HOLDR (PPH) moved further into positive territory. The iShares Russell 2000 (IWM) closed just below our stop, which is based on resistance of its 200-day moving average.

Higher turnover again confirmed yesterday’s positive price action, as institutional buying activity has begun creeping back into the market. Total volume in the Nasdaq surged 22% higher, but volume in the NYSE was only 6% above the previous day’s level. Although turnover rose in both exchanges, only the Nasdaq’s volume came in above its 50-day average level. It was the first time in five sessions that it did so. Both the S&P and Nasdaq registered their second straight “accumulation days” yesterday. However, the action in the Nasdaq was more positive due to both greater price gains and a more significant increase in volume. Market internals were solid across the board. In the NYSE, advancing volume exceeded declining volume by a margin of 4 to 1, while the Nasdaq ratio was positive by more than 5 to 1.

Clearly, overall market sentiment has changed over the past two days. Whereas many intraday rally attempts were fizzling out in the afternoon, stocks have been closing strong for the past two days. The handful of stocks that have broken out to new highs are holding well so far, and a plethora of stocks have begun to break out above their bases of consolidation or above multi-month downtrend lines. While the talking heads of the financial media may present a host of economic or geopolitical reasons for the market’s recent bullish action, the most likely cause has been the technical breakout in the Semiconductor Index ($SOX).

In yesterday’s Wagner Daily, we pointed out how the $SOX had broken out and closed above its 50-day MA for the first time in more than three months. We mentioned that bullish momentum of that breakout would likely carry the $SOX higher in the short-term, and that is exactly what happened. The $SOX built on Tuesday’s 3.7% gain by closing another 4.3% higher yesterday. As we have discussed numerous times in the past, the $SOX index usually leads the broad market because the semiconductor stocks are so heavily weighted within the Nasdaq, which tends to lead the other major indices. Given that the $SOX has rocketed 8% higher over the past two days, it’s not surprising that the major indices have also performed well. Because we wanted confirmation that Tuesday’s breakout in the $SOX was not a fluke, we did not yet buy any of the semiconductor ETFs. However, now that the $SOX has confirmed its strength by rallying sharply and closing at its intraday high on day two of the breakout, we will be stalking both the iShares Semiconductor (IGW) and Semiconductor HOLDR (SMH) for potential long entry. Ideally, we would like to see a 38.2% to 50% Fibonacci retracement of the $SOX’s two-day range, but a sideways correction by time would also provide for a low-risk entry from here.

While the semis and other tech sectors have been moving higher, a few sectors have been showing relative weakness to the broad market. The Oil Sector ($XOI), which has been in a long-term uptrend since the beginning of 2003, is in the process of failing last week’s breakout to a fresh all-time high and has demonstrated relative weakness over the past two days. From July 27 to August 8, the $XOI index consolidated at its high, but in a choppy, indecisive manner. On August 9, the index broke out above its range on an intraday basis, but closed near the top of its prior range. Three days later, it had fallen to the low of that range. The S&P 500 has gained a total of 2% over the past two days, but the $XOI has ignored the strength and has actually moved fractionally lower during that same period. If an index is showing such relative weakness that it can only move sideways to lower while the broad market is rallying sharply, what do you think happens when the market eventually corrects? That index is the first one to fall and its loss will typically double that of the broad market. The first chart of the $XOI index below illustrates the failed breakout, while the chart below that compares the price percentage changes of the S&P 500 and the $XOI over the past three days:

Our ETF Roundup guide shows there are twelve different ETFs that comprise the Energy sector. Of these, the S&P Select Energy SPDR (XLE) has one of the better looking chart patterns for a potential short sale if the $XOI index breaks down below support of its three-day low. Note that the popular Oil Service HOLDR (OIH) has a very different chart pattern than the $XOI index because it tracks companies engaged in various oil services as opposed to Oil Production and Exploration.

Recall that we also brought your attention to the iShares DJ Real Estate Index (IYR) a few days ago due to its failed breakout that occurred the previous week. IYR gapped up with the major indices on Tuesday, but again showed relative weakness yesterday by ignoring the stock market’s gains. We feel that IYR is in the process of setting a “lower high” on its daily chart, so it remains on our watchlist for a potential short sale. Confirmation of a “lower high” may come when IYR rolls over below yesterday’s low, especially if that happens while the stock market holds up.

Today’s Watchlist:

IYR – iShares DJ Real Estate Index
Short

Trigger = below 73.64 (below the Aug. 16 low)
Target = 69.30 (support of 200-day MA)
Stop = 75.27 (above the Aug. 16 high)
Shares = 400

Notes = This setup did not trigger yesterday, but we still like it for potential short entry today. Notice the new trigger and stop prices. Per the commentary and explanation in the August 15 issue of The Wagner Daily, we are targeting the REIT sector for short entry. If you receive a “shares not available” message from your brokerage firm on the short sale attempt, we recommend calling your broker and asking them to “locate” shares of IYR for selling short. Most brokers will be happy to do this and can usually find shares to borrow. If not, consider switching to a broker with a large list of stocks for shorting.

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):

stop 73.65

unrealized P/L = + $233

IWM short (250 shares from August 1 entry) –
sold short 68.65, stop 71.16, target 61.70, unrealized points = (1.74), unrealized P/L = ($435)

Closed positions (since last report):

net P/L = ($738)

SDS long (300 shares from August 16 re-entry) –
bought 68.50, sold 68.23, points = (0.27), net P/L = ($87)

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

$36,432

Notes:

MTG Opening Gap Rules

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