Saturday, April 21, 2007

Breadth Returns

The market was actually looking pretty good to me until I noticed Abby Joseph Cohen on CNBC Friday afternoon. Now I know for sure that the top is finally in.

Seriously, the best thing about Friday's action was that the indexes rallied from the inside out. After days of dreadful internals, stocks hit record highs on strong breadth and buy volume. Also, New Highs outnumbered New Lows by a very impressive 507-65. If you want to set some records, this is how you want to do it.

Even better, investors re-discovered their appetite for leading stocks. The IBD100 beat the broader market on Friday -- including the spunky Dow -- adding 1.3% as 77 of 100 stocks moved up. 16 stocks notched record highs, a solid number considering the IBD100 sloshed through a week of sub-par performance. The SPX was up 2.2% for the week, while the IBD100 added just 0.5%.

Volume slipped very slightly on Friday, though the chart below still looks excellent. MACD is very strong, some of the daily overbought conditions have eased, OBV bounced, and trend strength (ADX) is bottoming. If the sentiment indicators were correct, a week ago most investors didn't anticipate the NASDAQ at these levels this weekend.

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The weekly chart clears out the noise and actually looks even better. Volume accelerated this week, while ADX trend strength has started to curl upwards.

After moving higher for 5 of the past 7 weeks, the weekly NASDAQ is now very overbought. However, strong uptrends can keep a chart in this position for quite a while. For example, in 2006 the Composite stayed overbought for 3 straight months (Aug-Nov), as the index climbed over 300 points. The red, slower stochastic line still has a ways to go. MACD divergence is another thing altogether. It will be interesting to see how momentum vs. price plays out over the next several weeks.

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What a difference a week makes. Last Friday, the Banks were a shaky and feverish bunch. However, tame CPI numbers and solid Bank earnings revitalized the BKX this week. The Banks are back above their 10-week average and look poised for more gains.

Markets ultimately follow the direction of the Financials. If you'll recall, the Banks shot up early in the week, helping set the tone for the broader market advance. While "Dow 13,000" stole headlines, the Banks quietly outperformed the entire US market except for one sector: the Brokers. Below are both the Banks and Brokers, thankfully this week's #1 and #2 best-performing groups.

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While everyone focused on the Financials this week, the most unexpected development came from the Semiconductors. Like the Dow itself, INTC has posted gains in 15 of the past 16 sessions! Joined this week by strong performances from LLTC, TXN, MXIM and NSM, the SOX rallied up to 6-month resistance.

The SOX has tested this resistance 6 times in 6 months, and each time was dramatically turned back the very next week. The key to success for the chips is immediate follow-through. Consolidation would be OK, but the SOX will benefit most from taking out 500 as quickly as possible. Another deep selloff next week will spell trouble again, probably for the broader market as well.

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When stocks are rallying, talking about Treasury yields doesn't seem very exciting. However, next to decent earnings, lower yields were one of the primary drivers of higher stock prices this week.

Tame CPI data had interest rate doves cooing about Fed cuts again. Chief bond bull Bill Gross reiterated his prediction that the Fed will cut several times this year alone to save housing. Based on the known data, I remain skeptical of this. In the current economic climate, the only thing likely to break Bernanke's resolve (other than <2% core inflation) is rising unemployment.

Nonetheless, the bond pit strengthened the entire market this week (especially the Financials), but two areas stand apart from the others.

The first is the yield curve. For recession watchers, this week's bond action was the perfect tonic for a healthy yield curve. The 2-year/10-year inversion has now been normal for 4 weeks, and even survived a big test at 1.0 (chart below). Mainstream press coverage of this remains light (Bloomberg did publish an article on April 16), and most recession hawk economists remain very unconvinced. Q1 preliminary GDP comes out next week, which will probably bring the recession discussion back to the fore again.

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The second area Treasuries impacted was the Housing Index. Though I'm no housing bull, this week the HGX made a critical move. Earlier, I said that Banks and Brokers were the best performing groups this week. Actually, I "mispoke" (thanks, Alberto Gonzales). With a 5.8% gain, Housing outpaced even the Banks and Brokers.

The chart below shows that since the 2005 peak, the HGX is making a credible tour of its Fib levels. Over the past two weeks, it held at the 62% retrace, and bounced back above its 40-week. There are definitely some eager beaver investors in the builders. Regardless, it's unlikely the housing mess will be over until the most painful and financially destructive part happens: the price of homes fall. Right now, no one's buying. Like an after-holiday sale at Macy's, cutting prices hurts margins, but it stimulates demand. For now, there are no real signs prices have started to come down, and inventory continues to build.

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I began this post with a contrarian joke at Abby Joseph Cohen's expense (sorry, Abby). However, it was to help make a point about the current market. Abby Cohen is the poster girl for perma-bull hubris, and her story is a cautionary tale that every investor can learn from.

The reason we know Abby Joseph Cohen is because in February, 1991 -- at Goldman-Sachs -- she made a very gutsy call. With the Dow at 2365, she cut against her peers and said that the bottom was in. She was widely criticized for this at the time, but she was dead right, and it made ga-zillionaires out of lots of investors. When the correction hit in 1998, she said to Hold, and she was right again. More ga-zillionaires.

The problem came in 2000. In March, as the market tumbled and warning signs were everywhere, Abby Cohen ignored everything and recommended a mere 5% reduction in tech (from 70% to 65% of her model portfolio). She stayed with tech all the way down (her real failing), and the rest is history.

Abby Joseph Cohen is famous to us all because she stopped following the ball.

Even for the pros, it's easy to out-think yourself. As the current market proves, following the ball is far more difficult than it looks. However, unless you learn to do it with some success, it's hard to consistently outperform the indexes.

It's VERY tempting to break ranks and make anticipitory moves. This week in The Kirk Report, Charles Kirk interviewed the popular Bloomberg columnist and money manager, John Dorfman. It's a great interview, and Dorfman quotes the famous Wall Street joke,

"What's the difference between being early and being wrong? There isn't any!"

Dorfman's point is one echoed by pros across the ages: most investors make more money following the market than trying to get out in front of it.

I have no idea what's in store for the market near-term -- and especially not long-term. Fortunately, it doesn't matter. All I need to know is that the current trend is up. That said, there are a lot of forces at play that could change this trend. The market's overbought, economic data could be bad, earnings news could sour, and who-knows-what-else could change everything. Even more ominous, the Sell-In-May chorus can be heard everywhere this weekend.

The market's trending up, but it's no time to let your guard down. Long or short, watch your basket like a hawk.

See you Monday, and I hope you're having a great weekend.



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