USE 200-DAY LINE ON RELATIVE STRENGTH CHARTS AS A SCREENING DEVICE -- SEMICONDUCTOR UPTREND IS IN DOUBT -- AIRLINES AND ENERGY ARE ON BUY SIGNALS

ANOTHER WAY TO SCREEN MARKET GROUPS ... I'm a big believer in being in the strongest parts of the market -- and avoiding the weakest. There are lots of ways to do that. The Stockchart Performance Charts, for example, rank the various market sectors and industry groups over any time span span you wish. By using that tool, you can see that REITs, utility, and energy have been the three strongest market groups during 2006. Two of the weakest have been pharmaceuticals and semiconductors. I also require that market groups have strong chart patterns. I usually favor groups that are trading over their 50- and 200-day moving averages. I also make extensive use of relative strength ratios. Today I'm going to suggest another way to combine relative strength charts with moving averages to screen market groups. Yesterday I wrote about the fact that utilities were doing much better than transportation stocks. Charts 1 and 2 make the same case but in a more objective fashion. Chart 1 is a relative strength ratio of the Dow Utilities divided by the S&P 500. The RS line is trading above its 50- and 200-day moving averages. That's good. Chart 2 applies the same averages to the RS line for the Dow Transports. Notice the the RS line broke its 200-day average in late July -- and is still trading beneath it. The November upturn in the RS line failed at that major resistance line. The fact that the Transport/S&P ratio has fallen below its 50-day average is even worse. That suggests that the transports are a good group to avoid.

Chart 1

Chart 2

SOX FLUNKS RS TEST ... Charts 4 and 5 show why it's important to monitor the RS line as well as the group itself. Chart 4 shows the Semiconductor (SOX) Index spending most of 2006 below its 200-day moving average (making it one of the year's worst performers). The SOX did climb back over its 200-day line in mid-November which is a minimum requirement for purchasing the group. [It's now retesting that support line which puts its upside breakout in jeopardy]. Chart 5 paints a much more negative picture. It shows the SOX/S&P relative strength ratio over the last year. The ratio broke its 200-day average during May and is still below it. In fact, its back below its 50-day average as well. By applying the simple rule that the RS line for any group must exceed its 200-day line before purchasing it, the semiconductor group would have been avoided since May.

Chart 3

Chart 4

PHARMACEUTICALS LOOK SICK ... Charts 5 and 6 apply the same comparisons to the Pharmaceutical Index (DRG). Chart 5 shows the DRG climbing above its moving average lines during July (blue circle). The DRG gave an intermediate sell signal a month ago (blue arrow) when it broke its 50-day average. It's still trading over its 200-day line. Compare that to the RS line in Chart 6. The DRG/SPX ratio turned up in July and justified purchase of the group. The RS line gave an early warning in mid-September when it broke it 50-day line. A more serious sell signal was given when the RS line in Chart 6 broke its 200-day line at the end of October. In addition to showing that the RS line sometimes gives earlier signs of a trend change, the fact that it's below its 200-day line suggests that this is another group worth avoiding.

Chart 5

Chart 6

ENERGY IS A BUY CANDIDATE ... Energy qualifies as a potential buy candidate on both an absolute and relative basis. Chart 7 shows the Energy Select SPDR (XLE) having broken out of its 2006 trading range weeks ago. That's a bullish breakout. Chart 8 shows that the XLE:SPX ratio rose above its 200-day line (up arrow) on the same day. That puts both charts in uptrends. Some would argue that it's silly to wait so long for a major buy signal. Why not buy the XLE when its bouncing off its October lows. If you don't wish to wait for the RS line to break its 200-day average, you could use an alternative approach. One would be to do some initial buying when the RS line climbs over its 50-day line. That occurred near the end of October. Another approach is to require a point & figure buy signal on the ratio itself. Chart 9 shows that taking place at 39.78 (ratio value) during October. Whichever technique you choose, the important point is to make sure that the market index and its relative strength ratio are both on some type of buy signal. I find the 200-day average a very helpful screening device for more important trend changes.

Chart 7

Chart 8

Chart 9

AIRLINES ALSO QUALIFY AS A BUY CANDIDATE ... More news of airline mergers is boosting the entire group today. Chart 10 shows the Airline Index (XAL) have broken out to a new 52-week high more than month ago (which I pointed out at the time). That's a bullish signal. So is the uptrend in the Airline RS ratio shown in Chart 11. The XAL/SPX ratio cleared its 200-day line in mid-October and reached a 52-week high of its own. That shows absolute and relative strength. The airlines are rising while the transportation group is falling. That's because most of the recent transportation weakness is in the rails and truckers.

Chart 10

Chart 11

OTHER LEADERS AND LAGGARDS ... Among the nine S&P market sectors, the ones that are in relative strength uptrends are utilities (XLU), materials (XLB), consumer discretionary (XLY), energy (XLE), and financials (XLF). Moving average downtrends are evident in healthcare (XLV), consumer staples (XLP), and industrials (XLI). Chart 12 shows the relative strength ratio for the Technology SPDR (XLK) still trading over its 200-day average. However, it's slipped beneath its 50-day line suggesting the potential for more short-term weakness. It's major trend is still up. There are lots of ways to measure relative strength trends. Moving averages are one of them. You might want to give them a try.

Chart 12