Friday, July 20, 2007

25th Amendment Fractal

In a bizarre, fractal-like metaphor for Friday's OE ream job, George Bush is having a colonoscopy on Saturday, while Dick Cheney serves as acting President of the United States.

It's unusual to use dick, bush and colon in the opening sentence of a post without it (a) being a prank, or (b) violating Terms of Service. That said, my feelings about the market are a metaphor of how I feel about Mr. Bush's medical procedure:

It's okay for selloffs to hurt a little, but I really don't want complications to develop.

For now, heavy selling on Friday did hurt a bit, and it capped off a rocky week for stocks. The NASDAQ managed to bounce off the lows on Friday and close above its 13-day, but the action marked the 2nd distribution day in three sessions. In a continuing pattern, blue chips faired worse, while the NDX did better.

The outperformance by the NDX was noteworthy considering the ballast provided by GOOG, ERIC, ADSK, XLNX and GILD. It's a sign of strength that on a weak OE Friday, just 18 of 100 NDX stocks closed down 2% or more. Tech stocks are experiencing broad strength, and the NDX is a big beneficiary of this shift.

Despite earnings misses, subprime woes, inflation chatter, dollar dumping, peptic financials, $75 oil and OE, the stock market itself still isn't giving off the stench of a looming correction. Maybe next week, but for now the NASDAQ uptrend remains intact.

For example, not only are the indexes all within 2% of record highs, leading stocks continue to show fortitude. The IBD100 had an off-week, but it certainly was no train wreck. This week the IBD100 slid -1.9% -- less than the RUT -- while an impressive 35 stocks tagged new weekly highs. In a clear sign of consolidation, just 25 stocks saw heavy selling, while 15 saw buying and a whopping 60 stocks closed on volume lower than last week. Until the fundamental elite take a nosedive, institutional investors will continue to have a taste for stocks.

Short-term, the most problematic technical development is a bearish price megaphone. MACD, Stochastics and ADX all suggest that the bears are at the plate once again. They have a terrible batting average, but next week is a new inning. While downdrafts always deserve the benefit of the doubt, the bears have a lot of work ahead to inflict course-altering damage to the NASDAQ.

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The Tech Ratio confirmed above 3-year resistance this week, triggering a secular buy signal for technology stocks. This is the clearest evidence yet that a change in trend is afoot. It's worth noting that even with misses from GOOG, INTC and MSFT, the Tech Ratio didn't flinch. This shows the depth and efficacy of the signal.

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Another sign complementing the Tech Ratio is that -- after 8 years -- Growth is finally outperforming Value, and Large-Cap is outperforming Small-Cap. Below are 3-year ratio charts of Style and Capitalization. When the chart on the left is climbing, Growth is outperforming Value. When the chart on the right is climbing, Large-Cap is outperforming Small-Cap.

Both charts show that important bottoms have been formed, and that key resistance has recently been breached. When these charts are climbing in tandem, Large-Cap Growth is under accumulation, another positive for tech stocks.

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Price strength is the simplest and most revealing metric of tech mojo. While the broader market slipped, 6 of the 8 tech subindexes closed higher this week. Below are the Tech Index, Networking, Hardware and Semis. Software and Disk Drives also closed higher.

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One place not to be long are the Financials. Even as XLF confirmed below its 200-day, a handful of analysts mentioned "nibbling" here. Oy.

There's a famous Wall Street expression: what's the difference between being early and being wrong? There isn't any. Some famous shorting systems say that now is when the easy money is made on the short side. Before going long, make sure you're certain that a bottom is in. This isn't a market that's favoring value right now.

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The market has produced very nice gains in 2007, but the grapes have suffered on the vine to get there. Volatility continues to edge higher toward 10-year averages, which means that the weather isn't going to get much better either. The falling dollar favors metals, and you should consider tech while making sure that your focus includes large-cap growth stocks.

In addition to a slew of earnings, next week sees home sales, the Beige Book, unemployment and preliminary Q2 GDP. Lots of pin action potential.

Until then, have a great weekend.




Bill Luby said...

dk, if you ever get around to putting up a Hall of Fame or some such, this post should absolutely go in there. The lead is absolutely priceless!

The rest of the analysis is impressive in that it manages to keep up the pace. FWIW, I haven't heard anyone else talking about the growth vs. value theme lately.

Have a great weekend,


dk said...

Thanks for the comments, Bill. The growth vs. value shift is almost as important as large-cap vs. small-cap, but the latter has gotten all the headlines.