I’m short IYR, here’s why

The major indices showed divergence
for the second consecutive day last Friday, but this time the spread
between the Nasdaq and S&P was even greater. Although the S&P 500 and Dow Jones
Industrials were both unchanged, weakness in sectors ranging from Biotechs to
Semiconductors caused the Nasdaq Composite to fall 0.8%. The small-cap Russell
2000 lost 0.3% and the S&P Midcap 400 edged 0.2% lower. A modest recovery in the
final thirty minutes of trading wiped out the S&P 500’s 0.4% intraday loss and
reduced the Nasdaq’s closing loss by the same percentage. Nevertheless, the
Nasdaq still closed in the bottom 25% of its intraday range.

Mixed turnover levels confirmed last Friday’s broad price
divergence. Total volume in the NYSE declined by 1%, but volume in the Nasdaq
was 7% above the previous day’s level. The Nasdaq’s loss on higher volume caused
the index to register a bearish “distribution day,” its fourth within the past
four weeks. In the NYSE, advancing volume fractionally exceeded declining volume
but the ratio was negative by more than 5 to 2 in the Nasdaq.

One reason for the big price divergence in the last session is
that Gold and Oil stocks continued to show incredible relative strength, while
nearly all the other major sectors closed lower. The AMEX Oil Index ($XOI)
spiked 2.8% to close at another record high last Friday, as did the Oil Service
Index ($OSX). The CBOE Gold Index ($GOX), which plummeted more than 6.5% the
prior day, bounced back sharply with a 3.5% gain. The index is now less than 4%
off its all-time high. The StreetTRACKS Gold Trust (GLD), which mirrors the
price of spot gold, fared even better by wiping out 4.1% of the prior day’s 4.3%
loss. If currently trading the gold stocks and ETFs, we recommend taking a break
from doing so until prices stabilize a bit. The volatility in that sector is
simply too high right now in order to retain your positions without a high risk
of getting whipped out.

One sector that is presenting itself as a possible
short-selling opportunity is the Dow Jones U.S. Real Estate Index ($DJUSRE),
which is comprised of publicly traded REITs (Real Estate Investment Trusts). The
two primary ETFs that mirror the sector are the iShares/DJ Real Estate Index (IYR)
and the iShares Cohen and Steers Realty (ICF). Take a look at the daily chart of
IYR, which moves in lockstep with the $DJUSRE index:

From its March 17 peak down to its April 17 low, IYR dropped
8.4% off its all-time high. When it closed below its 50-day moving average on
April 10, IYR also broke support of its primary uptrend line that had been in
place since the low of October 2005. We spotted the weakness in IYR (and ICF) as
they were breaking down below their 50-day MAs and uptrend lines, but it is
often risk to chase a sector that has already made a substantial move in a
particular direction. Instead, we kept it on our radar screen and waited
patiently for a bounce into resistance, which is exactly what happened last
week. IYR has retraced 50% of the range from its last major selloff, which means
it has now run into a key
Fibonacci resistance
level. It also has rallied into resistance of its prior uptrend line from
the October low, which should now act as resistance. Further resistance is
provided by the new downtrend line that begins with the March 17 high. Put it
all together and we feel odds are good that IYR will soon make another move to
the downside and at least retest support of its prior low from April 17.
As such, subscribers will note that we are now stalking IYR for a new trade
entry on the short side. Trigger, stop, and target prices are listed in “today’s
watchlist” below.

As mentioned on numerous occasions throughout the past month,
the 1,310 area in the S&P 500 continues to act like a brick wall. Once again,
the S&P attempted to confirm a breakout to a new high, but the 1,310 level
pulled on the index like the gravitational pull of planet Earth. Although the
index has certainly been resilient and is holding up well since the April 18
breakout, the S&P will have a difficult time going higher if the Nasdaq
continues to show such relative weakness. The horizontal line on the daily chart
below illustrates the 1,310 “line in the sand” resistance level:

Until last Friday’s session, the Nasdaq Composite had a
similar chart pattern as the S&P, but the Nasdaq’s 0.8% loss caused the index to
give back nearly half of its gain from the April 18 breakout. Resistance of the
prior high at 2,375 remains the main obstacle preventing the Nasdaq from going
higher:

Although the tone since April 18 has been more bullish
overall, the major indices are each having a difficult time rallying above
resistance of their prior highs from last month. If they are able to overcome
those levels, many individual stocks and ETFs should surge to new highs as well,
giving us more opportunities. But for now, we are not seeing a lot of low-risk
trade entries. On the long side, most sector ETFs still have too much overhead
supply to contend with, but it is too risky to short most sectors at current
levels without confirmation that the major indices are going to fail their
current breakout attempts. The one exception we have found are the Real Estate
stocks and ETFs, which should have a difficult time going much higher even if
the broad market does.

Today’s Watchlist: