The Wagner Daily | December 27, 2006

Commentary:

A broad-based bounce in the stock market enabled the Nasdaq to snap its five-day losing streak yesterday, but volume fell to its lowest (regular session) level of the year. Stocks opened marginally higher, chopped around in a lazy, sideways range throughout the day, then edged slightly higher in the final thirty minutes of trading. The Nasdaq Composite, Dow Jones Industrial Average, and S&P Midcap 400 indices each gained 0.5%, while the S&P 500 advanced 0.4%. The small-cap Russell 2000 once again bounced off support of its 50-day moving average, registering a gain of 0.9% in the process. Each of the major indices closed near their intraday highs for a change, but the S&P and Nasdaq both failed to even test their previous day’s highs.

Turnover dropped to extremely low levels yesterday, indicating traders are more focused on enjoying the rest of the holiday season than jumping back in the market right after the Christmas holiday. In both exchanges, total volume was 20% lighter than the previous day’s levels. Excluding the shortened sessions of July 3 and November 24, it was the lightest volume day of the year in both the NYSE and Nasdaq. Given that this week is traditionally the slowest of the year, the lethargic turnover was no surprise. Again, it will be difficult to determine the true underlying health of the market until we see the return of institutional activity. Most likely, this won’t happen until next week, after the New Year’s Day holiday has passed.

Because of its seasonal volatility, the Retail Index ($RLX) is one sector we are following closely right now. Less than stellar holiday sales have caused the index to fail its recent breakout to a new all-time high. Further, many high flying retail stocks to begin seeing distribution that will could easily cause the $RLX to correct significantly further from here. Looking at the chart below, notice how the $RLX failed its mid-December breakout attempt and is now consolidating in a narrow range, below support of its 50-day MA:

With the index closing lower in five of the past six trading days, the $RLX could bounce or trade sideways for a while before going lower, but it looks like the sector is in trouble. More important than the 20 and 50-day moving averages now acting as overhead resistance is the fact that the index failed its breakout of a long base of consolidation. In weak markets, we have found that failed breakouts to new highs are one of the most profitable shorting strategies. This happens because the bulls who bought the new high are quickly forced to dump their shares, which in turn attracts the short sellers who detect the weakness. However, there are two caveats to this type of setup. First, the breakout attempt to a new high must have been from at least a multi-week base of sideways consolidation, as opposed to a parabolic trend. The $RLX obviously qualifies on this accord. Second, we wait for a breakdown below the low of its prior consolidation in order to have confirmation of the bearish reversal. In this case, a breakdown below yesterday’s low would represent a break below the recent range. If downward momentum in the $RLX index continues, it’s not unrealistic to assume a price target of the 200-day MA, presently at the 468 level.

If you wish to capitalize on the relative weakness in the Retail sector, there are several ways. First, you can obviously select the individual stocks within the sector that possess the weakest chart patterns. Ticker symbols of a few retail stocks we are already short in our hedge fund are: AEOS, SHLD, JCP, and ANF. Second, of course, are the Retail ETFs. The Retail HOLDR (RTH) is perhaps the most well-known, but we do NOT like it for a short setup here. The problem with RTH (and all the HOLDRS) is that they are comprised of only 20 individual stocks. Worse is that they were the leading stocks of years ago, not today. Better alternatives may be found with the StreetTRACKS Retail (XRT) and the S&P Select Consumer Discretionary SPDR (XLY).

In yesterday’s newsletter, we pointed out several key technical events that occurred in last Friday’s session: the Nasdaq Composite’s marginal break of its 50-day MA, the second test of the 50-day MA support for the Russell 2000, and the third test of the 200-day MA within the past month for the Semiconductor Index ($SOX). As if on cue, each of those indices staged obligatory bounces at these pivotal support levels. Yesterday’s rally pushed the Nasdaq back above its 50-MA, but the reversal attempt lacked overall momentum. We would not be surprised to see a choppy, narrow range throughout the rest of this week, but we expect a lot of volatility when traders return to “business as usual” next week. Keep watching the major support levels in the three indices we illustrated yesterday in order to determine the most likely direction the volatility will go.

Today’s Watchlist:

There are no new setups for today, as we expect action to be light and choppy ahead of the New Year’s Day holiday. Instead, we will focus on managing existing positions for maximum profitability.

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):

See important notes below regarding this position

stop 51.45

unrealized P/L = + $745

GLD long (400 shares from Dec. 19 entry) –
bought 61.25, stop 60.36, target 64.40, unrealized points = + 0.73, unrealized P/L = + $292

MZZ long (250 shares from Dec. 19 entry) – See important notes below regarding this position
bought 63.46, stop 60.14 (dividend adjusted), target 65.51 (dividend adjusted), unrealized points = (0.15), unrealized P/L = ($38)

Closed positions (since last report):

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

$59,350

Notes:

Note the new, tighter stop on QID.

Regarding QID and MZZ, both traded “ex-dividend” on December 20. As such, their prices were adjusted lower to account for the dividend payment that will be made to shareholders on December 27. The net result is no change in the overall profit or loss of the position, but stop and target prices had to be adjusted lower by the exact amount of the dividend distributions. For QID, an additional gain of $0.567 per share will be included in the performance reporting after the position is closed, while both the stop and target prices have also been lowered by this amount. For MZZ, the adjustment was $1.14 per share. Note that the “Unrealized points” and “unrealized P/L” figures already account for the dividend distributions that will be made. New guidelines will soon be put into place to simplify future occurrences of dividend and/or capital gain distributions for ETF positions. See the December 21 issue of The Wagner Daily for a thorough discussion of ETF dividend distributions.

Click
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