Saturday, March 24, 2007

A Steady Hand at the Tiller

Given Iran's naval hijinx going into a weekend, the markets displayed remarkable stability on Friday.

Stocks ended a strong week on an encouraging note. The continued reluctance by institutional investors to unwind positions -- especially in the face of geopolitical weirdness -- is an important positive for the market. Even though volatility remains elevated, big investors weren't spooked on Friday.

Leading stocks continue to reinforce this positive tone. The IBD100 edged slightly higher yet again, even though just 49 of 100 stocks moved up. Despite this ho-hum breadth, an impressive 20 of those stocks hit record highs, while a scant four printed distribution days.

Over the past eight sessions, each of the indexes has essentially double-bottomed at its 200-day and confirmed back above its 50-day via a high-volume, intraday reversal. In the process, the indexes recovered 2/3's of the Feb 27 sell wave. Things may change next week, but for now these aren't the signs of a market that's ready to roll over and give it all back.

That said, recoveries are tricky business. Four weeks is short for a correction (seven weeks is the historic minimum). It's also been a shallow dip of just 6-7%. This creates odds that favor wiggling sideways and lower from here -- possibly much lower -- but who knows? So far, institutions have been stingy about giving back gains. Capitulation -- if it's going to happen -- is apparently going to require something more serious than subprime mortgage hell and a Persian version of McHale's Navy.

Going into a weekend after a week of strong gains, volume slipping 17% on a 0.1% price fade is ideal action.

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For the week, both the Composite and the SPX gained a hefty 3.5%. However, these were the biggest gains for both the SPX and the Dow in over 4 years. The chart below shows that the problem was that weekly volume was merely average for all of the indexes. Considering the sharpness of Wednesday's rally, this low-volume surge carries the hallmark of short covering. Of course, that doesn't mean the market's going to give it all back either. Since the Aug 15 follow-through, the market has famously denied investors comfortable re-entry points. It will be interesting to see if that trend continues with the current Mar 21 follow-through.

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Following are a few other notable weekly charts.

After the indexes, if you've only got time to check out one additional sector each day, look at the Financials. This is the single largest group of stocks on Wall Street, making up more than 1/4 of all stocks traded on both exchanges. By their sheer mass, they offer great clues as to the direction of the market.

For the record, Banks recently tumbled a respectable 10%, then bullishly repaired 76% of that fall in just six sessions. Brokers fell a whopping 15%, then reclaimed 2/3 of that move, also in just six sessions. Such rapid recoveries are signs of strength, not weakness. The kicker is that Banks and Brokers also reclaimed their 200- and 50-day averages in the process. Like the IBD100, the Financials are telegraphing a market that continues to show committed buying interest. Neither of the charts below are out-of-the-woods, but this week's action was a good first step.

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Dow Theory holds that (among other things) the market isn't really healthy unless the Dow, Utilities and Transports are simultaneously all doing well. These three are now clustered in the tightest formation the market's seen in over 9 months -- since the start of the last rally. The Transports sit just 4.7% below a new all-time high, the Dow sits just 2.5% below, and the Utilities are parked just 0.5% off an all-time high. When the Dow, Utilities and Transports are all parked within 5% of new all-time highs, the market has historically performed well.

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The Feb 27 tumble really spooked investors. Two weeks ago, even though the market tumbled just 7%, and leading stocks, financials and the Dow group all recovered quickly, tracked the highest level of Bearish sentiment (67%) since Mar 2003! This week, despite the big reversal, Bearish sentiment improved only slightly to 61% -- the same level it was at the end of last May's sickening slide. Reactions this disproportionate to price slides are, of course, contrarian bullish. It also makes Wednesday's rally a little less surprising.

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Each week, the economy continues to show fresh wobbles and bruises. However, the market appears to be discounting this weakness in favor of conditions further down the road. Next week is the end of the month, end of Q1 and tax time. That's a flammable combo, especially with the VIX parked 30% higher than it was just three weeks ago. Looks like there's a chance of more fireworks next week as well.

Until then, have a great weekend.



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