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Today's Market WrapUp 01.29.2008 Mon Tue Wed Thu Fri Barbera Archive All Eyes on the Fed This week, our update is all about sectors and a look at some interesting charts. In the wake of last week's dramatic stock market sell off, we poured through our charts to see what looks seriously oversold and where ‘reward’ could be high, and where ‘risks’ can be managed. Be aware that over the last few weeks, the steady downtrend in stock prices world wide is strong confirmation that a bear market, possibly a bear market of epic proportions, has taken control. For months this column has warned readers of precisely this outcome, and only now, with prices badly battered do we see the first real hope for a recovery rally. That said, we are under no false illusions. The current tenuous lease on life courtesy of technical oversold readings is highly dependent on additional help from monetary policy. If the Federal Reserve does not cut interest rates by at least .50 basis points tomorrow, then the disappointment will reign supreme, and stock prices are likely to get very ugly once again. In our view, the Fed and other Central Banks have a great deal of control on what happens next. Should they cut rates tomorrow by 1/2 point? In this author's opinion the answer to that is a no-brainer, YES. The yield curve on the short end of the curve is still inverted, and monetary policy will not help the banking system until banks can earn a positive ‘carry.’ If the central banks were really on top of their game, then Europe and the Bank of England would be quick to follow on the heels of the Fed Rate cut this week and not let the American Central Bank stand alone. Without foreign support and the strong phalanx of a ‘unified front’ among the Central Banks, the problems of the bursting credit-debt bubble will likely render all central banks completely irrelevant within the next few months. As I see it, this is their big chance to act in concert and show the world that help is on the way. Like Trust, once lost, confidence can be the most impossible feeling to restore, and that’s what this is all about, maintaining the emotional well being and confidence of the masses. Investors don’t like losing money, and once burned badly, it can be a long time before they work up the confidence to invest again. If the Feds want to maintain asset inflation and not find BOTH HOUSING and STOCKS deflating at the same time, they had better get this right, because the downside from here will be unmerciful. Failure could quickly degenerate into a self reinforcing deflationary spiral, which once that kicks into high gear, will be followed with a tide of rising protectionism in which things go from bad to worse. In my view, the Central Banks are facing their single most important juncture in many, many years. Hopefully, it will not be their Waterloo, but I wish I could say I was 100% convinced as the rhetoric coming out of the ECB over the last few weeks has been confounding and really stupid. Throughout the ECB and Asia, (let alone America) the signs of an economic contraction are spreading throughout the globe reflected in economic indicators in every major country. What precisely is left to debate? I say this because while the charts look encouraging and indeed the market action over the last few days looks like it could be an important low, if the S&P is sent tumbling below 1280 by a failure to act on behalf of the Central Banks, then all will be lost. In our technical work, the 1270 level seen at last week's lows is now critical price support, with some of our short term parabolic SAR trend gauges now coming in at 1280. That’s the cut off delineation point between support and the abyss. Closer in 1320 on the S&P is shaping up as important price support for the index on the hourly charts and we would be concerned if that level was broken for more then an hour or so anytime over the next few days. On the upside, any move above 1370 would have to be viewed as bullish and confirming our thesis from last week that a large counter-trend rally is underway. It is our view that such a rally could be quite imposing and could last over a period of many weeks if the Fed and the Central Banks get it right. With this in mind, let's have a look at few sectors that show up prominently in our work. A long time favorite, we still see outstanding values in the Oil Service Sector, where fundamental P/E Ratio’s and PEG Ratio remain at ‘bargain’ levels. In the table below, we show a representative snap shot of the sector where P/E’s are well below market multiples and PEG Ratio’s, and the P/E divided by the 5 Year Growth Rate are all under 1.00. In the stock market today, this is virtually a unique situation and has been for several years as high day rates continue to underpin strong earnings power for these companies, most of which have long term, multi-year contracts with Oil majors.
On the technical side, we like to track sentiment toward the group using the inflow and outflow of capital at the Rydex Mutual Fund Family. Over the last few years, we have developed our own technical indicators to track when the group is in fashion and when they are being shunned. As can be seen on the chart below, at the present time in the wake of last week's decline, sentiment in the Oil Service sector is pretty much rock bottom with investors too frightened to step up to the plate. On a contrary opinion basis, that’s a rather positive element to have in place when considering the long side of any sector.
In addition to a bearish mood permeating the current climate, like the broad stock market, the Oil Service stocks are deeply oversold. In the next chart, we show our medium term Up to Down Volume Ratio for the sector, which last week clocked in with a fully oversold value below +90. In addition, other daily Advance-Decline Oscillators are also now presently oversold, consistent with prior substantial lows. Again, if the Fed doesn’t get it right, these kinds of readings may not mean much, but in the right climate, one of rising confidence, they could act as a powerful catalyst for a recovery rally.
Elsewhere in the Energy patch, most of the mid-to-large cap E&P companies are now also at least relatively oversold, with our medium term A/D Ratio moving down last week to hit its medium term lower band. On a longer term trend basis, the primary trend for these stocks is still up, although, it has weakened a bit over the last few weeks.
In looking at the chart of the widely watched AMEX Oil Index, the XOI, we note that last week the index came down to very important price support at its 200 day lower Bollinger Band. With the index closing today at 1373.20, the 200 day lower band finished at 1251.65 which would mark the equivalent downside ‘line in the sand’ for energy stocks. Is it unlikely that we see this index break below 1251 in the weeks ahead? You bet, but if the Fed makes a big mistake, then selling in other sectors could rapidly force even energy stocks to the downside as margin selling could force institutions to liquidate. Again, we believe this is very unlikely, but wanted to point out this critical support zone. Far more likely is the outcome of a recovery rally, as like the Oil Service stocks, the large cap E&P companies are also deeply oversold, with Up to Down Volume oscillators near multi-year lows.
Yet another major sector that we note continues to act well is the Healthcare sector, which in broad terms held up wonderfully during the most recent market decline. Within Healthcare, we also note that at the moment, probably the most out of favor group are the large cap Pharmaceutical companies, names such as Johnson and Johnson (JNJ), Pfizer (PFE), Glaxo-Smithkline (GSK), Novartis Ag (NVS), Sanofi Aventis (SNY) and Merck (MRK). Here again, our longer range Up to Down Volume Oscillator resides at levels which in the past have often led to important bottoms.
In addition, we noted that during this latest stock market panic sell off, the relative strength ratio of large cap Pharma versus the market improved materially with the group going down considerably less. In view of the fact that many of these stocks are heavily weighted in index baskets, we were impressed with the relative strength show, where almost half the group avoided tumbling to fresh 52 week new lows along with the S&P. While this still may not be an ‘all clear’ for big Pharma, it is a definite sign of building internal strength which as I pointed out in Chapter 3 of the “Master Traders” book in 2006, can be an indication that a more material change in trend may be falling into place. From here, what is needed would be upside follow through and breakouts above short-term resistance, and of course, lots of help from the Fed.
At the close today, the S&P 500 ended higher by 8.34 index points to finish at 1362.30, the DJIA ended at 12,480.30, up 96.41, with the NASDAQ Composite higher by 8.11 index points to finish at 2358.02. The 10 Year Bond yield closed at 3.66%, up .07 bps, while Feb. Gold finished down 4.10 at $923.00. That’s all for now, Frank Barbera Copyright © 2008 All rights reserved. CONTACT
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