On the long side, I like these 4 sectors

Stocks concluded the
holiday-shortened week with a session of modest gains last Thursday,
as small caps and tech stocks helped the Nasdaq to show relative strength. The
broad market showed weakness in the morning, but the S&P 500
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after finding support at its prior low from April 11. Although the index
attempted to put in a short-term double bottom, the S&P 500 managed only a 0.1%
gain, as did both the Dow Jones Industrial Average
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the Nasdaq fared better with a 0.5% gain. The small-cap Russell 2000
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rallied 0.5% as well. Despite the small gains of the last two days, both the S&P
and Nasdaq still finished the week lower by 0.5% and 0.6% respectively. The Dow,
however, managed a 0.2% gain.

As anticipated, turnover again declined in last Thursday’s
pre-holiday session. Minimal participation from institutions caused volume in
the NYSE to decline by 10%, while volume in the Nasdaq was about the same as the
prior day’s level. Volume in the NYSE was so light that it fell below the April
10 level, which had just registered as the lightest volume day of the calendar
year. Of the past nineteen sessions, turnover in the NYSE has exceeded
its 50-day average level only one time! Although the popular financial
media may not be discussing this peculiarity, we feel it is very important to
note. An extended period of such light turnover tells us that, for one reason or
another, institutions have completely backed away from taking a stand on either
side of the markets. This matters because institutional trading activity
typically accounts for more than 60% of the stock market’s average daily volume.
As such, the direction that institutional traders decide to take leading stocks
is usually the direction the entire broad market follows. But when there are is
no clear indication of institutional activity, caution is definitely in order
because stocks can make a swift move in either direction when the mutual and
hedge funds eventually return to the markets aggressively. We were expecting the
advent of quarterly earnings season to generate higher volume levels, but that
has not happened so far.

For the past two days, the 50-day moving average has acted
like a magnet on the S&P 500. When the index closed below support of its
six-month uptrend line on April 11, we mentioned this was a negative sign for
stocks, but also cautioned against aggressively starting to sell stocks short
due to support of the S&P’s 50-day
moving average. But while the closely-watched
indicator has indeed halted the recent decline in the index, the S&P has also
failed to muster up enough momentum to significantly bounce off the 50-day MA.
Instead, the S&P closed the past three days virtually right on that
moving average:

The good news is that we feel the index will make a
substantial move away from its 50-MA within the next day or two. If it attempts
to rally, be aware of new resistance at its prior six-month uptrend line.
Presently, that uptrend line is coming in just below the 20-day
moving average,
just below the 1,300 level. Additionally, a lot of overhead supply remains from
traders who bought the month-long consolidation in the S&P in anticipation of
new highs. Certainly, we can expect to see those people selling into strength on
any bounce because human psychology of the average retail investor is that he
only “hopes to break even” after a stock or ETF has moved against him.

Conversely, short-term support for the S&P 500 is now defined
around the 1,283 area. This is the level where the S&P found support last Friday
morning and reversed, so it could easily do the same again. The three-day chart
of the S&P below illustrates how the index has attempted to form a short-term
double bottom at the 1,283 level:

If stocks head lower and the 1,283 level is broken, we will
probably see a rapid drop down to the March lows in the 1,268 to 1,272 range. If
downside momentum accelerates quickly enough, it would not be unreasonable to
foresee a sharp selloff down to the February lows, which is just above the
200-day
moving average. But for now, the S&P 500 is simply glued to its 50-day
moving average. We share these support and resistance levels with you only so
that you may be prepared in the event of a swift move in either direction within
the next day or two. Our overall bias remains cautiously bearish, but we are
prepared to cover our short positions at a moment’s notice because we do not yet
have enough confirmation that the recent weakness will see further
follow-through. Regardless, we feel that recent action has been negative enough
to “test the waters” on the short side of those sectors and indices that have
been showing the most relative weakness.

Although both sectors finished last week on a bounce, the
Biotech and Semiconductor sectors remain among the weakest sectors right now, as
do the Pharmaceuticals and Utilities. On the long side, the only sectors we
would consider are: gold and metals mining, and oil/oil service. For broad-based
ETFs, the S&P 500 Index (SPY) is probably the clearest short setup due to its
break of the daily uptrend line.

Open ETF positions: