SMALL-CAPS VERSUS BIG TECHS -- RUSSELL 2000 GETS OVERSOLD BOUNCE -- NASDAQ 100 MAINTAINS UPTREND -- CISCO POWERS BIG TECHS -- THE SUB-PRIME PROGRESSION -- REITS AND HOMEBUILDERS SURGE -- TARGETS FOR OVERSOLD BOUNCES
A TALE OF TWO MARKETS ... Today's Market Message was written by Arthur Hill. John Murphy will be back tomorrow. - Editor
Stocks rebounded over the last three days, but these rebounds need to be considered in the context of prior price action. While the advance in the Russell 2000 looks like an oversold bounce, the surge in the Nasdaq 100 looks like a continuation of the current uptrend. This discrepancy highlights the crosscurrents at work within the market. Large-cap techs held up quite well in recent weeks and small-caps led the way lower. John showed some long-term charts on Friday and these showed the recent breakdown in small-caps. The Performance Chart below shows five key indices over the last three weeks. This period encompasses the sharp decline from late July to early August and it is clear that small-caps led the way lower. The Russell 2000 is the magenta line at the bottom. The Nasdaq 100 and Dow held up the best with the smallest declines. The black line at the top represents the Dow and the blue line is the Nasdaq 100.
Chart 1
RUSSELL 2000 GETS OVERSOLD BOUNCE... The Russell 2000 declined over 10% in less than three weeks and broke below the May-June lows with a gap down. This support break was bearish and the index found support near the March lows. Such a sharp decline in a short period of time created an oversold condition and the index was ripe for a bounce. Just how far might this bounce carry? Broken support turns into resistance and I would expect this oversold bounce to stall around 810-820. Traders may also want to watch the 200-day moving average, which marks resistance around 806 and the 50-day moving average, which marks resistance around 828. The 50-day moving average is declining and will hit 820 in a few days.
Chart 2
NASDAQ 100 HOLDS SUPPORT ... While the Russell 2000 declined over 10% from 19-Jul to 3-Aug, the Nasdaq 100 declined around 6.5% and held up much better. In addition, the Nasdaq 100 forged a higher high in mid July and held above its June lows last week. Despite the sharp pullback, the index never broke support and the medium-term uptrend never reversed. The overall advance shows a clear progression of higher highs and higher lows. A downtrend cannot start until there is a lower low and the Nasdaq 100 has yet to forge a lower low. The advance may be slowing and losing momentum, but it has yet to actually reverse and it is premature to turn bearish on the Nasdaq 100.
Chart 3
Chart 4
CISCO LEADS BIG TECHS... Cisco (CSCO) gapped higher and surged above consolidation resistance with big volume today. CSCO was the most active stock today with over 190 million shares traded. Cisco has around 6 billion shares outstanding and this means that 3% of its outstanding share traded today. On the price chart, the stock broke to a 52-week high in mid July and then consolidated. While the market broke down from mid July to early August, the Cisco kid held strong and maintained support around 28.5. Even though today's gap and breakout are bullish, RSI moved is nearing 70 and the stock is quickly becoming over bought. Consolidation resistance now becomes support around 30-30.5 and this is the first test on any pullback.
Chart 5
Chart 6
THE SUB-PRIME PROGRESSION... This 2007 Performance Chart shows the progression of weakness related to the sub-prime lending problems. It all started with the Homebuilders SPDR (XHB) and its breakdown in early March. This was followed by a breakdown in the REIT iShares (IYR) in mid May and the Finance SPDR (XLF) in mid July. Year-to-day, the Finance SPDR (XLF) is down around 5.58%, the Homebuilders SPDR (XHB) is down around 25.22% and the REIT iShares (IYR) is down around 10.50%. The S&P 500 is still in positive territory for the year with a 5.58% gain.
Chart 7
OBJECTIVES FOR AN OVERSOLD BOUNCE... The declines in the Homebuilders SPDR (XHB) and REIT iShares (IYR) over the last few weeks created oversold conditions and both were ripe for a bounce. The hardest hit often produce the sharpest recoveries and today was no exception. Short covering and bargain hunting triggered these rallies and these moves are considered corrective advances within a larger downtrend. This is part of the normal ebb and flow of the market. Stocks rarely go straight down and movements against the larger trend are all part of the game. Corrective rallies, as these counter trend movements are called, usually retrace 38-62% of the prior decline. In addition, we can look for resistance levels from broken support and key moving averages. I like to find a convergence of indicators to establish resistance zones and upside targets for these oversold bounces.
Now let's apply this reasoning to the REIT iShares (IYR). IYR peaked around 88 in late April and declined to around 69 in early August (~21%). The ETF broke support at 80 in June and this support level turned into resistance in July. The ETF became oversold in late July as RSI dipped below 25 on 27-July. IYR then firmed and consolidated in the low 70s for two weeks. Today's break above consolidation support is short-term bullish, but within the context of a larger downtrend. This makes the advance a corrective rally and we can start looking for resistance points. A 50% retracement of the April-July decline would extend to the 78.5 region. There is also resistance around 77-81 from the July consolidation and the falling 50-day moving average marks resistance at 78.3. Taken together, I would expect this rally to run into trouble around 77-80.
Chart 8
Chart 9
TARGET FOR XHB... For the Homebuilders SPDR (XHB), I would expect the corrective rally to run into trouble around 30-31. A 50% retracement of the prior decline (late June to early August) would extend to around 30.5. There is also resistance around 29.5-31 from the early July consolidation and the falling 50-day moving average marks resistance at 30.5. Taken together, it looks like this rally will run into trouble around 30-31.
Chart 10
Chart 11
