Sunday, July 01, 2007

At the Half

As the band takes the field at the half, this game is a tough call for investors.

For now, both the bears and the bulls continue to hold the line at each test. However, the bears have an overall advantage, and short-term risks clearly remain to the downside.

One of the great disconnects is that the fundamental leadership continues to outperform. While the broader market has dipped slightly since Wednesday's rally, the IBD100 shot up another 1.6% since then to close up 1.2% for the week. On Friday, 55 of 100 IBD100 stocks printed gains, 19 stocks hit new highs and just 8 saw any signs of selling pressure.

Historically, markets don't tumble into corrections when stocks with the best fundamentals are doing well. Of course, markets can still sell off very hard like they did in February and March. However, the leadership fell in-line with the broader market then, and stocks recovered quickly and pressed on to new highs.

However, the market is different now. The subprime fiasco has created much more uncertainty, and that has generated fear. This is why the VIX is up, options are expensive, inverse ETF's are seeing record volume and the NYSE sports the highest level of short interest since 1931. Investors are spooked.

The good news is that being spooked isn't what causes lasting damage to the stock market. Terrible earnings wreck markets, and for now, there are few signs that Q2 profits are set to disappoint. I have often wondered if the scent of Q2 earnings strength is the invisible force driving the IBD100 higher.

Regardless, it's hard to feel good about an index that has seen 11 distribution days in 8 weeks, has falling money flow and negative OBV, yet is still in an uptrend, sits above its 13-day, and is just 1.2% below a 6-year high. If this feels confusing, that's because it is.

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It's worth noting that the weekly Composite continues to project a much less confusing (and more bullish) assessment of the NASDAQ longer term. Even though +DI and both CCI's are below 100 and descending. it's not all bad, as Friday marked the 13th straight week that the Composite has closed above its 10-week.

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If you're looking for some clarity amidst the confusion, here's a quick summary of 11 things that the market itself is saying:

1. Avoid rate-sensitive stocks. Utilities, Banks, Brokers, REIT's, Mortgage-related, Insurance, etc. are weak and lots of uncertainties surround this group. The market is behaving like the worst is still to come with the mortgage mess.

2. Avoid Housing and Housing-related holdings. Prices haven't fallen enough to stimulate demand and mark a bottom yet.

3. Defensive stocks, such as Consumer Staples, Drugs and Healthcare are currently offering no tactical advantage.

4. Precious metals and mining stocks are not providing much of a safe haven either.

5. Retail is weak. Buy the stuff, not the stock.

6. Energy stocks remain solid. These are prone to unexpected pullbacks, but there's no evidence that the long-term run in energy is over. Good stock-picking in this sector is a plus. Hurricane season awaits.

7. Technology stocks -- once the most radioactive sector in the market -- are under accumulation. Internet, Networking and Telecom are leaders, and Semis are improving. The NDX is slowly establishing a leadership role.

8. Industrial and Materials stocks are generally doing well, especially those with strong international exposure.

9. This isn't a market that's rewarding bottom-feeding. As odd as it sounds, growth is outperforming value, a fact being corroborated by lagging Defensive stocks (see #3 above).

10. There's analyst negativity about foreign stocks, but the stocks themselves continue to show strength.

11. Overall, large cap stocks are outperforming small-cap, but the best individual performers continue to be small-cap.

The market looks like it wants to break down, but the sellers keep running out of gas at support. With all of the divergences and negative mojo, it seems likely the bears will get a few more chances to take it lower. Expect low volume, above-average holiday volatility this week. Also, expect surprises.

I'm on the road Thursday-Sunday, and it's a very busy trip. With the current schedule, once I leave Thursday morning it's unlikely I'll have time to post until Monday.

Hope everyone had a great weekend. See you tomorrow.



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