Transports manage successful back test

Monday's quiet trading did turn up one key positive; the back test of former resistance-turned support of the Dow Jones Transportation Average ($TRAN). The move was accompanied with a bullish hammer on higher volume, giving two more ticks in the bull column. Stochastics are on a 'sell' from overbought levels, so it could take a test of the 50-day MA to work a more solid bounce and reset stochastics.


This strength should reflect itself in the Dow index with a break of January-April resistance. Positive money flow suggests accumulation:


Can the semiconductor index be a proxy for the Tech averages? The semiconductor index is loitering around its 50-day MA having traded sideways since January. The relative difference between the 50-day and 200-day MAs has narrowed from its max 20% deficit suggesting the worst is behind this index. But unlike the Nasdaq 100, it has failed to break past its 50-day MA. Technicals are neutral-to-bearish so there is little indication that it could do this soon. Without confirmation, the breakout in the Nasdaq 100 will fail (just as moves in the Dow need the support of the Transports as per Dow Theory).

Semiconductors break 50-day MA (again!)

Watching the Semiconductor Holders (SMH) with interest (over and above the long position I hold in them). Tuesday saw its second break of its 50-day MA over the past few weeks. The last one didn't hold so the question is will it do so now? Recent volume has been strong, suggesting there is more than retail trading going on here. I have redrawn a consolidation triangle, a break of which to the upside would confirm the 50-day MA crossover as bullish. If it can create some air to its 50-day MA it will have a good chance to mount a challenge of its 200-day MA once the inevitable back test appears.

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Copper watch...

Last Friday's Jobs Report send bearish ripples through the market, but the real news for February wasn't the jobs report, it was the breakout in copper prices. Many will cite weakness in the dollar as the cause for the surge in commodity prices but this is too simplistic an argument. The following chart shows copper prices priced with respect to the Euro index:



Why copper? As a key industrial metal for technology stocks (semiconductors in particular) it is an important measure for early economic expansion. From October through to early February demand for the metal declined as economic conditions deteriorated. However, February saw the start of a recovery over and above a simple decline in weakness for the dollar.

If the copper:euro ratio can crack past 2.68 I reckon any chance of a recession will go kaput and it will mark a firm bottom for the markets. Markets discount economic conditions by 6-9 months, so Friday's data was priced in long before it was reported. Breadth indicators are in deep oversold territory, and Barry Bears are revelling in the meltdown so one has to ask, who is left to short? Who is left to sell who hasn't sold already?

Now is not the time to be throwing the hands in the air, now is a time to be rotating out of the underperformers into stocks which will lead this market out. Financials and Technology is where the action will be...

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Semiconductor Holders (SMH)

The 50-day MAs are the talk of the town for the various indices. The SOX is stuck below its, but the Semiconductor HOLDRs (SMH) broke through - a nice follow through to Tuesday's higher volume resistance breakout. If this breakout holds it will be good news for the Nasdaq and Nasdaq 100.


In defence of the SOX, it is on the verge of a major breakout of both its 50-day MA and declining resistance from December. If it takes its lead from the SMH and breaks though it will create some room for a nice run to the 200-day MA.


It's not hard to find wags waiting for the next decline, knocking recent market strength. I would prefer to see a more active retest of January lows, but the more I look at this market - the less I think this will happen.

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Buyers range established

The last two days have seen tweezer bottoms in large cap indices, a bullish piercing pattern in the Nasdaq 100, and a (somewhat) bullish engulfing pattern in the Nasdaq. But my favorite, the semicondutor index, refused to buckle in the face of broad market selling over the last week - although it would be hard pushed to shed more than it has already. Wednesday's bullish hammer is the icing on the cake. Watch for a fresh MACD trigger 'buy' (but well below the bullish zero line, a weak signal) as other technicals improve:


The Semiconductor index has a Point-n-Figure chart target of 260 (which would amount to a 50%+ decline from its 2007 highs!). To negate this target the index would need to muster an upside breakout, with 364 likely to define such a threshold.


The technology sector is one of the first to push higher from a recessionary environment. Chips should lead other technology based sectors. For the purpose of disclosure I am long some deep-in-the-money calls on the Semiconductor HOLDRs (SMH) with the intention of taking some money off the table on a test of the 50-day MA.

As for other indices, use the 2-day range and apply Fibonacci retracements. If looking to buy then split orders to cover fills on the 38%, 50% and 62% retracement, adding on a break of the 2-day high when further retracements appear unlikely. Stops go on a 1% break of 2-day lows.

How bad can things get?

With markets either in, or about to start, cyclical bear phases I took a look at the extent of the damage which could follow. I started with the semiconductor index (well, the Semiconductor HOLDRs, SMH) as this was the index most hit by the selling in recent months. I looked at the relative percentage difference between the 50-day and 200-day MAs as this removes some of the short term volatility which can skew daily extremes. The SMH only has 6-years of data, but there is evidence to suggest worse could follow.



However, like an elastic band, ever swing to one extreme tends to be followed by a counter move of similar weight in the other direction. During the bear market bottom and bounce, the relative difference between the two moving averages reached extremes of +36% and -27%. The current difference is a paltry +11% (but a bounce could see a 50-day MA rise 8% or more above the 200-day MA).

With the S&P it is possible to look back over the last 50 years. Even here it is apparent we haven't approached anything like a significant divergence. The current difference between the 50-day and 200-day MAs is only 1.6%, but significant counter moves tend to occur when the difference between the averages pushes out to 10% or more.



The alternative scenario to consider is that markets are still in cyclical bull phases, where major divergences between the 50-day and 200-day MAs are unlikely. However, it would be hard to argue for a cyclical bull phase in the Semiconductors and Russell 2000, and it may not be long before large caps join the aforementioned indices into more protracted declines.

Something to consider in the months ahead.

Semiconductor bounce

One of the most overlooked sector hammerings in recent months has come in the semiconductors. The semiconductor HOLDRs (SMH) have shed 26% from their July highs compared to 27% in the much hyped financials.

Yesterday's late afternoon challenge by the bulls in the broader market should see some initial good will Tuesday morning (Futures are up a tad). This could provide a longside opportunity in the SMH. The 60-min intraday chart shows a decent capitulation following the gap from $30.75, with prices stabilizing in $29.25-29.75 range.



The coming week could see a nice counter rally opportunity back to gap at $30.75, with the potential for follow through (based on the health of the broader indices) to the 62% Fib retracement at $31.75.

The initial risk is about $0.50, but this could be reduced to around $0.25-0.30 if one got a fill at $29.25.

On the option front; $22.50 February 16th calls at $7.10 from the Ask give relatively low downside risk with enough time built in for the bounce to unfold. An alternative is the $25 May 17th call at $5.25 which would build in a seasonal advance. The more risk loving might like to take the $30 January 19th call at $0.54, or the $30 February 16th call at $1.03.

Time for the semis?

If you are not wanting to invest into an individual stock, and are looking for something of value which hasn't the taint of financials, then the semiconductors could be the sector for you. Technology stocks have played a background role in the cyclical bull market, losing interest to the more energetic, commodity-based stocks. Technology is one of the early leaders out of recession and the semiconductors are a key component of any recovery. The sector has taken a beating since July, losing over 20% of its value - a true bear market and a worrying measure of the state of the economy. However, a number of factors have come into play which give the sector a distinctly bullish (technical) feel:

[1] The recent break of declining resistance
[2] New near term highs
[3] A clean break of the 20-day MA
[4] A bullish divergence in the CCI
[5] Rising MACD following earlier 'buy' signal (although deep below the bullish zero line - so watch for a retest of 401 lows).



Dollar cost averaging into the Semiconductor ETF (SMH) for the next few months should see a prosperous new year.