Saturday, May 05, 2007

A Big Week for Stocks

This market hasn't rewarded fighting the tape.

For investors tempted to do so, Friday's action showed the usefulness of keeping a keen eye on market internals. After a busy morning, I checked in on the action just in time for the abrupt lunchtime selloff. Volume was strong as the market slipped into the red, potentially a very troubling development.

However, a quick check of the market internals showed that while the market was falling, surprisingly all three internal indicators stayed positive. This suggested more of a buyer's strike than a worrisome pickup in selling pressure. It's also a pattern that the market has flashed 5-6 times in the past 8 weeks. This stealthy strength -- especially on stronger volume -- was a tell that buyers were likely to scoop up the discounted shares, which is exactly what happened. When the market truly turns, internal weakness will be undeniable.

The IBD100 sent a similar message on Friday, as it too stayed positive throughout the noon dip. It also beat the broader market for the third straight day, adding 0.9% as 68 of 100 stocks moved higher. Record highs have increased in each of the past three sessions as well. On Wednesday there were 9, then 16 on Thursday, and an impressive 22 on Friday. Also on Friday, just 4 IBD100 stocks printed distribution days.

For the record, the IBD100 has had a bumpy April, due largely to earnings volatility. nastar takes the time to chart the IBD100, and his last posting shows how the IBD100 has lagged the NASDAQ in April. This lag is a long way from a Sell, but it's important for the IBD100 to accelerate and begin leading again. Continued divergence from the Composite will almost certainly spell trouble for the market. Thanks, nastar. This is a useful chart, so please keep posting it.

Below, the Composite looks excellent, especially the hammer on a 4% volume surge. Black hammers have a reputation as topping indicators, but pullbacks continue to be bought. The bigger weakness is that Money Flow is flat.

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A week ago, the market had printed three new highs on declining volume and weak internals. A selloff was a near certainty, but the next step was very unclear. I commented that it would be interesting to see where the market would be this weekend, and especially how it got here. What a surprising journey it's been.

The chart below shows the power of the bid that's currently driving this market higher. In just 8 hours of trading on Mon and Tue, 1 1/2 weeks of gains were wiped out. Then, buyers stepped in to turn the indexes around and push them to record highs. This was an impressive show of strength, and a sign that the bulls aren't messing around. The pullback almost tagged the 10-week before heading higher, and the resulting hammer is very bullish. Quien es mas macho? El toro es mas macho!

The SPX, Dow, NDX, NYSE, MID, SML and WLSH all reversed mid-week to print new record highs. The strength is also a global phenomenon. Australia, Brazil, Mexico, Toronto, France, Italy, Germany, Belgium, London, Seoul, Shanghai and Singapore all hit record highs this week. This bull is hunting in packs.

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For over four years, pundits have been recommending that investors pre-emtively avoid small-cap stocks and buy large-cap. However, the market itself disagreed, and the RUT rallied 140% while the SPX gained just 70%.

Things may finally be changing however, and it's the market doing the talking this time. I created the DIA:IWM ratio chart below after reading an article I can no longer find (thanks, unknown author...and apologies). It shows that large cap stocks appear to have put in an important bottom. A break above above 1.634 resistance would likely trigger an acceleration of the large cap phenomenon.

What does this mean? Bill Luby wrote a great post about what history suggests could happen as a result of this shift.

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One benefactor of a return to large cap could be technology stocks. Is It Time to Buy Tech? shows that tech finally appears to have put in an important bottom last summer, and is currently looking for follow-through. Though it's still early for a buy trigger, the Tech Ratio has improved since that post, and is now banging at its 8-month downtrend line. When this chart breaks above 0.236, a noticeable shift in tech stocks will be visible to the naked eye.

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Speaking of tech, the SOX added to its breakout and notched a new 52-week closing high. This is a very nice-looking chart.

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NASDAQ volume continues to accelerate with this rally, another encouraging sign.

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Finally, the TOF Ratio remains in a near-perfect condition. By mid-day Friday, it had grown very hot. However, the noon sell-off spooked option investors and cooled the ratio down.

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It's been a long, long time since the market has run this hard for so long. For example, the Dow has been up 23 of the past 25 sessions. If you go back to 1896 to see what happened after other occurrences of 23-for-25, you'll find that...well, there haven't been any! The Dow has never posted gains in 23 of 25 sessions.

This has lots of investors v-e-r-y nervous. Investor sentiment is starkly negative, the VIX stubbornly refuses to go down, the economy is wobbly and many of the bearish arguments make a lot of sense. Regardless, the stock market has caught the scent of something, and seems very focused on moving higher.

Following the ball is very different from being reckless. Save an act of God, markets have a knack for giving off unmistakable warning signs. Maybe they will next week, but for now, stocks continue to look like they have more upside ahead. For contrarian investors, it's a positive twist that so many investors remain concerned.

Until next week, have a great weekend.



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