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Here is the Deal:

After closing down for two days straight the Dow blasted higher from the open on the back of overnight strength. Then around 2:00 PM Greenspan said he feared a “dramatic contraction” in the Chinese market. The US market didn’t like that one bit and a heavy round of program sells went off sinking the whole market. The market tried to bounce out of a 2:30 PM low, but the last half hour was soft and the Dow closed lower for a third consecutive day. Several Dow stocks are beginning to show signs of tiring.

For a second time in three days, the NYSE Tick index reached -1000 at the weakest point during the day. That powered a 105 correction from high to low and the Dow’s trend line shift continued. The 105 point correction is a little small relative to recent corrections but it is in line. If 13,520 is broken on Thursday look for support buyers to come in around the 13,460 level. That would bring the correction to a solid 150 points, about as much as we have seen over the past two months.

While higher highs were reached, technically the Dow has been correcting for three days straight after an extended run higher.

After four days with little economic news, Thursday’s reports, Durable Good orders and New Home sales figures for April, should provide a welcome guidepost. Wednesday’s sell off was a reaction to comments from Mr. Greenspan. Other than that, there were no significant changes on Wednesday. The economic data Thursday morning could set a different tone in the market. I expect a gap opening Thursday. Signs of improving economic strength should be well received.

Here’s why:

The Dow was up 69 points at its high of 13,609 and it fell a solid 104.59 points to its low of 13,505.65 when it was down just 34 points. It closed down 14 at 13,525.65, right on the 13,520 support level. With three down days in a row the Dow has lost a collective 30 points and that isn’t very much. While it is 85 points off its high, we just can’t get worked up over a little decline. That said; internally, some of the Dow stocks are starting to show some kinks in their armor.

Are Exchange Traded Funds impacting the market?

Everyone loves Exchange Traded Funds. The number of ETFs has ballooned over the past few years and trading volume continues to swell. People are constantly suggesting I start an ETF service, and at some point I probably will, even though I am not a huge fan of them. Some of them are great, like the foreign market ETFs. Let’s face it, buying the iShares MSCI Malaysia Index Fund ETF (EWM) is a great way to participate in the Malaysia market. Note: EWM is the hottest ETF at this time based on three and 12-month PRS Ranking.

When it comes to US stocks, we know Telecom is a hot group right now. The TTH (HOLDRS Telecom ETF) is the top non foreign market ETF right now, and it comes in at #8 on the list. It has 12 stocks in it. And not surprisingly, six of them have performed better than the ETF and six worse than the ETF. This is part of what makes ETFs so great. You can buy a small group of stocks with one click getting a portion of the group’s strength while avoiding the risk of getting stuck with the wrong stock in a hot group.

Looking at the PRS Time Plane today I started wondering if the surge in ETFs could impact market behavior. The chart below shows the 12-month PRS Time Plane. The blue line shows the average 12-month PRS return for stocks with a PRS ranking of 90. Red = 10. The thin lines represent 1000 trading day averages for each one. Currently, despite the huge rally, the top performing stocks are well below their historical average return for 12-months.

In the 90’s the metrics oscillated above and below their average levels, which is pretty common as it is an average level. With the bubble in late 99 - 2000, we saw the strong stocks spike to ridiculous levels, but notice that the red line barely reached its average. In 1999 everyone was piling into the hot stocks at the expense of the weaker stocks. We saw another bubble like event at the end of 2003, which led to the 2004 consolidation. And look where we are now.

At present the best performing stocks are up about 50% on a 12-month basis, well below the historic average, which hovers between 65% and 75%. The 10^th percentile of stock have actually gravitated up to their average of -20%, which is about even with where it was in the 90’s, before the bear market. It is odd for the strong stocks to perform below their average return while at the same time weaker stocks are in line with their average performance level.

One way to explain the currently unique configuration is the increasing popularity of ETFs. You see, in the 90’s traders would see the telecom sector is hot and they would buy the hot telecom stock, thus driving them even higher. They might buy a little of the telecom dogs just in case one came around, but essentially the underperformers, even in a hot group, were neglected while the hot stocks got even hotter.

With ETF trading, those underperforming stocks get a lift and or are supported at the expense of the hot stocks not garnering the extra dollars they used to get. Because there is so much focus on the ETF, while the hot stocks are always going to be hot, those ETF trading dollars are spread over the whole group of stocks in the ETF rather than a majority of the dollars going to the really hot stocks.

Whether you are a fan of ETFs or not, they are hear to stay. With their current popularity there are indications they are having an impact on the market and the character of the trading action. Whether that impact proves beneficial or detrimental is yet to be determined. One thing the chart above does tell us is that even though the S&P 500 is making new all time highs, the 90^th percentile of stocks is performing very poorly relative to its historic average. Relative to the past 15 years, based on the performance of the stronger stocks, the market is not overheated.

The S&P 500 failed to hold 1527 for a third consecutive day. The SPX pushed higher and couldn’t hold it pulling back to close right on obvious support at 1522. Lower support is 1518 followed by the previously mentioned breakout support level, 1512-1514.
At present this is just a minor pullback. Falling below the trend line will set a slightly different tone. There are reasons to look for a more pronounced pullback. We still have an outstanding high-to-high time span that needs to be corrected. The SPX would have to break 1498 this week to turn its weekly trend down. With a lot of support between 1500 and 1515, if it happens it will be a serious wake up call.

The Russell pulled back with the Dow after making a higher high: The Russell did leave an unattractive upside tail on Wednesday. That often signals a short-term direction change, and after three solid up days a consolidation should not be a surprise. Ideally any further corrective action should hold above the 831 to 834 area, and that doesn’t leave much wiggle room. Pulling back into the trading range will not look bullish.  

Again the NASD followed along with the Russell. Wednesday’s reversal is less than ideal for the near-term bulls, but a successful test of the breakout level, about 2570, will look very healthy. The NASD left a gap at 2560 on Monday and seeing a brief move lower to fill the gap won’t be of great concern. The key of course is a quick recovery on any minor break of support.

The NDX turned its daily trend down on Wednesday. Technically the S&P and Dow turned their daily trends up and then back down on Wednesday. The interesting thing for Thursday is Dow and S&P 500 can turn their 3-day trends can turn down while the NYSE and NASD would have turned their up on Wednesday had they been pointing down. Even if they turn down Thursday they could turn back up on Friday. Also note that recently 3-day trend changes have aligned well with near-term turning points.
As for the weekly trends, it has been 90 days since the S&P 500’s last weekly high making this move the 7^th longest since 1962, and all the ones longer were between 1963 and 1971.

Detailed Trend Report on Web & CLX Count and Weekly Signal Counts & NYSE & NASD 5-day up and down volume charts

Total breadth was -1062 after being as high as +2100. Total volume picked up on Wednesday, which is typically the busiest day of the week. The surge of program selling just after 2 PM accounted for a large part of the volume increase. Though breadth was negative, directionally volume was not skewed to the downside.

While we saw a pickup on new 52-week highs this week, the rest of the internal metrics remain in their divergent patterns. The most notorious is the NYSE 10-day AD line, which has stagnated near the zero leaving a series of five lower highs in place over the past two months. However, this metric remains buoyant refusing to move to a true oversold level.
10-day Advancing volume remains in a state of contraction with its own series of lower highs. The situation on the OTC side of the market isn’t much better, but it did go through a price correction recently.

On the next thrust higher we need to see these 10-day metrics break from their negatively divergent patterns. Such a development will leave a much more hospitable internal condition in place.

With some economic news on Thursday look for a rambunctious open. For overnight trading the main concern is that Greenspan’s comments reverberate around the world making a mess of overnight trading. But Greenspan is just a man. He has shocked the market with comments like “irrational exuberance” before. I think that one slowed the market for a couple of days, but it did little to alter the underlying fundamentals, and the rally continued.

Jim Patterson

Most Obvious chart resistance levels: ()
Dow  13,520, 13580, 13650, 14,350
SPX 1522, 1528, 1550
NASD 2565, 2580, 2595, 2620, 2641
NDX 1890, 1900, 1907, 1922, 1934, 1950, 1978
NYSE 9940, 10,000
RUT-2K 826, 831, 836, 841, 847, 851

Most obvious Chart Support levels:
Dow 13,520, 13,450, 13,380, 13,280, 13,220, 13,131, 13,050, 12980, 12,900, 12,750
SPX 1522, 1512-1514, 1501, 1491, 1475, 1436, 1397, 1373, 1362, 1340
NASD 2580, 2563, 2548, 2520, 2480, 2455, 2425, 2400, 2385, 2335, 2316
NDX 1905, 1890, 1875, 1855, 1840, 1822, 1808, 1795, 1775  
NYSE 9850, 9750, 9690, 9620, 9510, 9400, 9350, 9280
RUT-2K 836, 831, 826-7, 820, 810, 808, 803, 790, 760

Here’s where we are now:

NASD 100 Index (NDX) Trading System, trade the QQQQ:

The NDX failed to achieve the higher Fibonacci resistance level of 1932-1935 despite clearing 1922. With Greenspan comments, 1905 support was quickly reached. After 1905 comes 1895 support, but prices should be able to bounce from current support.

S&P 500 (SPX) Trading

>> 3-16-07: With strength on the open it made sense to hold off on the SDS purchase for an hour or so. The SDS bottomed at 60.55, well below the 60.80 I am using as an entry price. We have a full position in the SDS with an entry of 60.80. 3-20 we added another 50% position to the SDS when the SPX pushed above 1407. 100% @ 60.80 + 50% @ 59.60
We moved to 200% long the SDS with the addition at 54.00. That brings our average cost to 58.8.
The SDS closed at 51.50.

Tactical Stock Trading Powered by Patterson Relative Strength

CRNT rec Long 5/8 @ 7.78, stop 7.85 close, target > 9, closed at 8.71
PDA rec Long 5/14 @ 33.12, stop 32, target 38, closed at 34.62
UNCA rec Long 5/22 @ 16.98, stop 14, closed at 16.98

CRNT reached a high of 9.06 on Wednesday, above our $9 target price for a 15% gain.

UNCA is a New PRS momentum long. We will use Wednesday’s closing price as the entry price of record.

We bought WMT June 45 Puts @ $0.25 as of 5/16
We bought AAPL July 110 Puts @ $6.60 as of 5/16

WMT remains in a solid down trend. Monday it broke 47 support. Wednesday WMT traded above $47 but couldn’t stay up there. Good news from TGT provided a brief relief but the problems at WMT are not going to quickly abate and the stock is set to continue lower.

AAPL, The iPhone is coming the iPhone is coming, and it will be available as a “pay as you go” or as they used to call them, “Disposable” phone. Wednesday there was a comment that the pending iPhone launch will reduce iPod sales for the month.

** PRS Open Actives making noise:
 

Jim Patterson
Editor
Tactical Trading Outlook

Here is the Deal:

After a strong broad market Monday we were looking for consolidation type action Tuesday with the potential for the Dow to close lower for a second day in a row. We saw some corrective action over the first half of the day. Then the broad market came on strong but the Dow wasn’t ready to go. It continued to consolidate and closed lower for a second day in a row. The main thing is the broad market was solid and continued its out performance in healthy fashion.  

The Dow held support at Monday’s afternoon lows and managed to push a bit higher in the afternoon as the broader market was surging higher. Overall the Dow remains within a corrective pattern that started on Monday. It has significant support at 13,520, only 50 points from the high, which isn’t very much of a pullback.

Support is obvious at 13,520. If broken we should see a fairly quick slide down to 13,450, but any more than that will be out of line with recent history. Higher Fibonacci extensions are all over the place, 13,635, 13,660 and 13,700.

Again there is virtually no economic data on Wednesday. Thursday we get Durable Good orders and New Home sales figures for April. After four days with very little in the way of economic data the stage is set for measurable market reactions, but it is still a day away. Target Stores reports earnings on Wednesday morning. That may give the retail sector something to key off of. For now, we are seeing a little consolidation in the Dow and S&P with a back drop of broad market strength. For now, Goldilocks is rocking hard and the bar appears well stocked.  

Here’s why:

Hold it, Stop the Presses! The Dow did something it hasn’t done since late March. The Dow closed down for a second day in a row. Amazingly, after closing down for two days in a row, it remains less than 50 points off its all time high and less than 20 points off its closing high.

Historically when these huge streaks have ended, it hasn’t been very pretty on a near-term basis. But I can already tell you this two day decline is virtually non-existent. Unless something really crazy happens to the downside on Wednesday, history says the pullback won’t amount to much and higher highs should not be far off. From a pattern stand point the consolidation is likely near its end.

The Dow traded in a 57 point range. It was up 43 but closed down 2.93 at 13,539.95. It fell 16 points in the two down days.

The S&P 500 failed to hold 1527 again. That almost sounds negative, but the fact is the S&P 500 is consolidating at a high level. It may need to dip a fuzz lower near-term before pushing higher, but at this point the S&P has done nothing wrong other than being extended to the upside. We should see higher highs to complete the move.
We did see some afternoon weakness and while that is less than ideal, the action is consistent with pattern expectations. 1522 is the obvious support area with more important support just a couple points lower between 1518 and 1520. We continue to expect the S&P to find support above 1518. Breaking 1518, while not expected at this time, will signal a test of the 1512-1514 breakout level, which is much more serious for the bulls.

The Russell consolidate for a half a day and continued higher: It was another solid day for the broad market with the Russell pushing higher in what now looks like a breakout move. Technically it was a low volume day and though we would prefer bigger volume, it was also a consolidation type day for a significant segment of the market. So far this week the Goldilocks scenario of broad market out performance relative to the Dow and S&P 500 is playing out, and it looks great.

The NASD followed on the heels of the Russell with a solid push above and closed above its old highs. Some afternoon weakness pulled prices back a bit, but for now we can attribute it to the influence of the Dow, which struggled to pullback lower and close down for a second day in a row. Near-term support is now the old high of 2580. That isn’t much wiggle room, but for now the NASD has cleared its old highs on a closing basis and should move higher.

The Dow and S&P 500 both turned their daily trends down. This confirms a minor consolidation is under way. The indices bounced from the turn levels and with no follow through there is no need to make a big deal over it at this time.

Detailed Trend Report on Web & CLX Count and Weekly Signal Counts & NYSE & NASD 5-day up and down volume charts

Total breadth was +1089. That is pretty good considering it was a flat day for the market. Again we saw NASD breadth greater than NYSE breadth for a second day in a row. This typically happens closer to an important low than an important high. Bottom line, we are seeing money shift towards the NASD and Russell 2000 stocks, and it may come at the expense of the larger Dow stocks. As liquidity driven as everyone keeps saying the market is, there still isn’t a ton of cash pushing everything higher like we saw in the late 90’s, or even in 2003 for that matter. The important thing is the broad market is coming on strong now.

Total volume was down from Monday. With the Dow and S&P down on the day we can call it a consolidation day, even though the broad market was firm. Call it a consolidation on reduced volume, which sounds bullish to me, especially considering no important support levels were challenged.

There was a slight contraction in new 52-week highs on Tuesday. Again, it was more of a consolidation day than an upside day so again I don’t think we need to make a big deal over it.

The Put/Call ratios spiked up above 1 on Tuesday and the Index only put/call ratios were above remarkably high with very heavy put activity on the S&P 500. As of the close I show an S&P 500 index put call ration of 6.37, which is abnormally high.

At the end of the day we have a very minor two day consolidation and no meaningful news until Thursday. The Dow broke the streak of not closing down two days in a row but it has been extremely mild. Once this corrective phase runs its course, probably before lunch on Wednesday, we should see higher highs, ideally lead by the broad market.

Jim Patterson

Most Obvious chart resistance levels: ()
Dow  13,545, 13580, 13650, 14,350
SPX 1522, 1528, 1550
NASD 2565, 2580, 2595, 2620, 2641
NDX 1890, 1900, 1907, 1922, 1934, 1950, 1978
NYSE 9940, 10,000
RUT-2K 826, 831, 836, 841, 847, 851

Most obvious Chart Support levels:
Dow 13,450, 13,380, 13,280, 13,220, 13,131, 13,050, 12980, 12,900, 12,750, 12,000
SPX 1519, 1512-1514, 1501, 1491, 1475, 1436, 1397, 1373, 1362, 1340
NASD 2580, 2563, 2548, 2520, 2480, 2455, 2425, 2400, 2385, 2335, 2316
NDX 1905, 1890, 1875, 1855, 1840, 1822, 1808, 1795, 1775  
NYSE 9850, 9750, 9690, 9620, 9510, 9400, 9350, 9280
RUT-2K 836, 830, 826-7, 820, 810, 808, 803, 790, 760

Here’s where we are now:

NASD 100 Index (NDX) Trading System, trade the QQQQ:

The NDX pushed higher Tuesday despite weaker action on the NYSE. The next area of Fibonacci resistance is 1932-1935 once 1922 is cleared. The NDX should continue higher on Wednesday without much of a pullback. This will maintain a very bullish pattern.   

S&P 500 (SPX) Trading

>> 3-16-07: With strength on the open it made sense to hold off on the SDS purchase for an hour or so. The SDS bottomed at 60.55, well below the 60.80 I am using as an entry price. We have a full position in the SDS with an entry of 60.80. 3-20 we added another 50% position to the SDS when the SPX pushed above 1407. 100% @ 60.80 + 50% @ 59.60
We moved to 200% long the SDS with the addition at 54.00. That brings our average cost to 58.8.
The SDS closed at 51.57.

Tactical Stock Trading Powered by Patterson Relative Strength

CRNT rec Long 5/8 @ 7.78, stop 7.85 close, target > 9, closed at 8.79
PDA rec Long 5/14 @ 33.12, stop 32, target 38, closed at 35.21
 

UNCA rec Long 5/22 @ 16.14, stop 14, closed at 16.14

UNCA is a New PRS momentum long. We will use Wednesday’s closing price as the entry price of record.

We bought WMT June 45 Puts @ $0.25 as of 5/16
We bought AAPL July 110 Puts @ $6.60 as of 5/16

** PRS Open Actives making noise:
MLM made a very strong push above 146 on solid volume.
TSS made a very strong thrust higher to new highs on very solid volume.
CCBL is positioned for an upside breakout.

ICE continues to perform well.
 

Best of the Best: table shows all stocks with 3, 6, and 12-month PRS Rankings of 96 or higher.  Last prices are as of 2:30 PM Tuesday.

Jim Patterson
Editor
Tactical Trading Outlook