Don’t be deceived by the Dow

October 4, 2006
Deron Wagner

Stocks
reversed opening weakness and moved into the plus column later in the
morning, but the rally ran out of gas around 1:00 pm EDT, causing the
market to drift lower throughout the remainder of the session. The
major indices were mixed yesterday, although the financial media
focused only on the fact that the Dow Jones Industrial Average gained
0.5% and finished at a new all-time high. The Nasdaq recovered from a
0.5% intraday loss to close 0.3% higher and the S&P 500 similarly
gained 0.2%, but the gains in the three most popular market indices
distorted the relative weakness in the small and mid-cap arena that
prevented many leading stocks from making headway. The Russell 2000
fell 0.1%, while the S&P Midcap 400 lost 0.3%. This divergence is
important to note because the Russell and S&P Midcap indices
usually outpace the other indices on strong days of broad-based buying.

Total
volume in the NYSE surged 23% higher yesterday, as volume in the Nasdaq
came in 8% above the previous day’s level. The S&P 500 and Nasdaq’s
gains on higher volume technically enabled both indices to register
“accumulation days” yesterday, but unimpressive market internals, along
with the weakness in leading stocks, failed to confirm the bullishness.
In both exchanges, advancing volume exceeded declining volume by only a
fractional margin of 1.1 to 1. Generally, we like to see a positive
ratio of at least 2 to 1 in order to confirm the strength of “up” days
in the broad market.

A few
weeks ago, we discussed a few of the international ETFs that were
acting well. Of those, the one that still has the best chart pattern is
the iShares Xinhua China 25
(
FXI |
Quote |
Chart |
News |
PowerRating). This ETF, which tracks mainland
China’s equivalent of the Dow, is still consolidating near its high,
but looks even better now because the range has tightened up. Also, the
longer a base of consolidation forms, the more likely that a subsequent
breakout will hold up. As the chart below illustrates, a breakout above
the 82.30 level in FXI would be quite bullish:

The
PowerShares Golden Dragon China Index
(
PGJ |
Quote |
Chart |
News |
PowerRating) is another ETF that tracks
mainland Chinese companies. Like FXI, it too has been consolidating in
a narrow range, but it is much further off its May 2006 high.
Nevertheless, a breakout above the high of the horizontal price
resistance illustrated below would present a rather low-risk buying
opportunity:

Check
out the 200-day moving average (the orange line) on the chart of PGJ
above. It is another clear example of how the 200-day MA always acts as
a major area of support or resistance. We discussed this yesterday
regarding how the iShares DJ Transportation (IYT) was consolidating
just below the brick wall of its 200-day MA. With PGJ, it is the
opposite situation, as the pivotal moving average has been pushing the
price higher over the past several months. Notice how the 50-day MA has
also perfectly converged with the 200-MA, another factor that should
help to eventually lead to a nice breakout.

It’s
true that the Dow managed to close yesterday at a fresh all-time high,
a few points above its January 2000 high, but don’t be deceived.
Because the index is a popular gauge of the general public’s market
sentiment, it is often discussed as a barometer of the market’s general
health, but it’s important to realize that the other indices remain
well below their record highs. The S&P 500 is still 14% off its
March 2000 high, while we may never even live to see the Nasdaq recover
back to its all-time high over the 5,000 level. The lagging index is
still a whopping 56% off its March 2000 high. While it may be fun and
exciting to talk about the merits of the Dow being at a record high,
we’re simply cautioning you against distorting the reality of the “big
picture.” History has shown that isolated rallies in the Dow are
typically short-lived when the other indices are not in sync.
Therefore, unless we suddenly start to see a lot of upward momentum in
the Nasdaq, we believe your best bet is to remain positioned on both
sides of the market by simultaneously being long the sectors with
relative strength and short those with relative weakness.

Open ETF positions:

Deron Wagner is the head trader of Morpheus Capital Hedge Fund and founder of Morpheus Trading Group (morpheustrading.com), which he launched in 2001. Wagner appears on his best-selling video, Sector Trading Strategies (Marketplace Books, June 2002), and is co-author of both The Long-Term Day Trader (Career Press, April 2000) and The After-Hours Trader
(McGraw Hill, August 2000). Past television appearances include CNBC,
ABC, and Yahoo! FinanceVision. He is also a frequent guest speaker at
various trading and financial conferences around the world. For a free
trial to the full version of The Wagner Daily or to learn about Deron’s other services, visit
morpheustrading.com or send an e-mail to
deron@morpheustrading.com
.

Don’t be deceived by the Dow

BUY THE FEAR, SELL THE GREED

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