Looking For Leadership…

The market remains in a test of the downside on both the NASDAQ and S&P 500 indexes. I would like to say that the move lower on Wednesday came at the hands of the Fed speak following the FOMC meeting. The commitment to QE3 was made clear as a result of concerns relating to the lack of growth in the economy, inflation heating up (maybe due to all the stimulus?) and slow job growth. In other words, the Fed hasn’t seen any improvement since the last meeting on 9/12. If we are going to see improvement in the areas of concern we would have to produce policies favorable to a change. Based on the current actions that isn’t going to happen any time soon, thus the downside has gained some momentum in the broad markets.

Scanning the ETF universe we find the inverse funds continue to rise to the top. Filtering and ranking the move in the ETFs by the last 5, 10 and 21 trading days we can get clearer picture of what sectors are leading during each interval and determine what rotation is taking place in the markets.

Over the last week the winners have been short natural gas, short energy, short semiconductors, short oil and short silver. Thus, the leadership is on the downside and it is defined by commodities being 4 0f the 5 leaders. Semiconductors is the fifth sector leading lower and has been the undoing of the technology sector which ultimately led the NASDAQ index lower. The short term selling is very well defined and the opportunities in these ETFs were built over the last month, but accelerated over the last five days.

It is interesting as well to look at the leadership for the last month or 21 trading day and see in some instances the leaders were the opposite of the current leaders. Example the best performing ETF in the filter was Natural Gas (long) for the last month. The five day leaders was the inverse natural gas fund. China was one of the country ETFs to show on the monthly scan for leadership and we have been discussing the positive break higher in FXI and GXC. The leadership on the downside was still present from small caps and technology. Both were among the leaders in the monthly scan.

Conducting these types of scans and filters are beneficial to see the short term rotation of leadership in the market. It is also helpful in shedding light on the direction or trend short term. As the inverse funds become the top performing ETFs it shows and defines a change in leadership. If the shift is big enough we will see a major trend development take place. That is where we are currently as the S&P 500 index breaks the short term up trendline and approaches a potential trend change short term. The longer term trends are still in play on the upside and have another 3-5% on the downside before those trends are threatened. Either way, the shift or rotation of sectors is challenging the current trends in play.

Having said all that, the conditions on the NASDAQ and Small Cap indexes are oversold short term. Thus, we could see some kind of relief bounce or move to the upside. Be prepared for the buyers to step in and take advantage of what is perceived as bargains. It is important to understand the psychology of the markets as it is the analytical data. A move back towards the 1430 level would be normal for in the current activity.

Apple announces earnings today and that will set the tone for the broad markets. If the numbers are good on the upside it will provide some peace of mind to investors and add momentum to a bounce.. However, if they miss it will likely reinforce how bad things have become over the last two quarters. If you are still an owner of Apple stock be prepared for some volatility similar to what you have been experiencing over the last two months. Unless they beat by impressive numbers there will still be plenty of questions raised by both sides.

The best course of action sometimes is cash and we have raised our allocation on the pullback. We will gladly put it back to work as the opportunities present themselves. To that end we anxiously await the outcome and direction relative to the current break of support and the constant warnings from companies relative to their outlook for the economy. The Fed confirmed their concerns at the conclusion of the FOMC meeting on Wednesday as well. Move cautiously, use discipline and manage the risk of your portfolio one day at a time.