SELLING FINANCIALS AND BUYING CHIPS -- ROTATION IS THE NAME OF THE GAME
FINANCIAL STOCKS CONTINUE TO TUMBLE ... Heavy selling that started in insurance stocks is spreading to the entire financial sector. Two of the day's biggest casualties are Countrywide Financial (Chart 1) and JP Morgan (Chart 2). CFC is trading under its August low and its 200-day moving average on monster volume. JP Morgan has gapped down to a two-month low. Banks and brokers are two of the day's weakest groups. But that heavy selling of financials shouldn't obscure the fact that some money is rotating elsewhere. Technology has been the strongest sector through the recent market weakness. Last week I wrote about software stocks (like Microsoft) that were showing good chart patterns. Today I'm taking another look at the chips which continue to show bottoming tendencies.
Chart 1
Chart 2
SOX HAS BEEN YEAR'S WORST GROUP ... I've been writing about money coming out of former market leaders like basic materials. Bank and insurance stocks had also been doing relative well prior to the last week. When money comes out of former leaders, it has to rotate somewhere else. Semiconductors are one of the likely candidates. For one thing, they've been the year's worst performers. Money coming out of the best performers often finds its way into the worst. Secondly, the Semiconductor (SOX) Index appears to have bottomed in early September, and has been outperforming the S&P 500 since then. Within the SOX, certain stocks are starting to show upside leadership. Like Advanced Micro Devices.
Chart 3
AMD REACHES FOUR-MONTH HIGH ... Whenever an industry group starts to show signs of bottoming, there are some stocks that take over leadership within the group. For a stock picker, I believe that's the way it should be done. First find a group that appears to be turning up (like the chips). And then look for individual leaders in that group that are leading it higher. AMD certainly qualifies. Chart 4 shows the chip leader having broken through its 200-day moving average to reach a new four-month high. [One of the simplest way to find market leaders is to see which ones break their moving average lines first]. Volume has also been rising. The relative strength line along the bottom is a ratio of AMD divided by the SOX. The rising ratio line shows that AMD is leading the group higher.
Chart 4
TXN IS ANOTHER SOX LEADER... Texas Instruments is another chip leader. The stock gapped higher yesterday on strong volume. It's still trading well below its 200-day moving average. But the TXN:SOX ratio is rising. That's a sign of group leadership.
Chart 5
ALTERA HAS BEEN A CHIP LEADER SINCE THE SPRING... Another chip leader is Altera. Chart 6 shows the stock moving up for a test of chart resistance (and its 200-day average) near 21. A close over that chart barrier would also break the down trendline extending back to the early 2004 peak. Most impressive of all is the ALTR/SOX ratio line. It bottomed in April and turned up again in July and October. If the SOX group does start to rise (as I expect it will), Altera should be one of the strongest stocks in the group. There are two ways to participate in a chip rally. One is to buy one or more of the leaders in the group like the ones shown here. Or you can buy the entire group.
Chart 6
SEMICONDUCTOR ETF TESTING DOWNTREND... One of the simplest way to participate in a potential upturn in the chips is to buy an Exchange Traded Fund -- like the Merrill Lynch Semiconductor Holders (SMH) plotted below. The chart shows that the chips have had a rough year both on an absolute and a relative basis. However, I believe that downtrend will be challenged. Chart 8 shows why.
Chart 7
ON BALANCE VOLUME IS CLIMBING... One way to tell if a group is undergoing accumulation (buying) is to study its volume pattern. And the volume flow is encouraging. If you compare the size of the green (up) and red (down) volume bars since September, you'll see that most of the big bars are green (with one notable exception in late September). An even better way to track the direction of the volume flow is with the On Balance Volume (OBV) Indicator. OBV is a running cumulative total of upside and downside volume. Volume is added on updays and subtracted on downdays. The direction of the line is all that matters. And, as Chart 8 clearly shows, the OBV line is most definitely rising. That greatly increases the odds for an eventual upside breakout in the chip ETF and its related stocks.
Chart 8
ROTATION IS THE NEW GAME... In my closing paragraph yesterday I addressed the question of whether or not this was a good time to put money into the market. It's true that the major blue chip averages are still under pressure and aren't showing any convincing signs of turning up. But focusing on the major averages alone misses an important point. The real action in the market is beneath the surface and is focused on rotations into and out of market sectors and industry groups. Over the last week, we've seen money coming out of basic materials and financials. At the same time, we've seen some money flowing into technology stocks like the chips and software. At least that's one of the points I've tried to show over the last week. When one group falls, there's usually another one that's turning up. And that's the way I think this market has to be played. It's not so much a question of if an investor should be in the market, but where. Right now, I happen to believe that semiconductors are one of the groups that money can be committed to. How you choose to do that is up to you.
