Real Estate ETFs are worth watching now

The broad market suffered heavy
losses Monday, causing the major indices to fall back down to near
their May lows. The small-cap Russell 2000 plummeted 3.2% and the 2.2% loss in
the Nasdaq Composite
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and Dow Jones Industrial Average
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slid 2.4%. Although stocks gapped open slightly lower yesterday, most of the
losses resulted from steady intraday downtrends in the major indices, each of
which finished at their worst levels of the day. As we discussed, the
"churning" that occurred in the first hour of last Friday’s session
foreshadowed yesterday’s bearish action and resumption of the broad market’s
four-week downtrend.

Volume levels started out lower yesterday, but turnover
picked up dramatically as the selling intensified in the afternoon. As of 1:30
pm, when the S&P 500 was down only 0.6%, total volume in the NYSE was on pace
to be 22% lighter than the previous day’s level. However, trading activity
surged higher as the broad market selloff picked up momentum in the afternoon.
By day’s end, volume in the NYSE had exceeded the previous day’s level by 3%.
The losses on higher volume were indicative of institutional selling and
caused a bearish "distribution day" to register on the S&P. In the Nasdaq,
turnover also increased in the late afternoon, but that exchange still saw a
7% drop in total volume. Market internals were just plain ugly. Declining
volume in the NYSE pounded advancing volume by a whopping margin of more than
10 to 1! Do any of you ever recall seeing a worse ratio? We don’t. The
Nasdaq’s declining/advancing volume ratio was negative by 7 to 1.

As the extremely bearish market internals confirmed,
yesterday’s selling was quite broad-based, leaving no major pockets of sector
strength in which to hide. One sector that did manage to close higher was the
Dow Jones Real Estate Index ($DJUSRE), but only by 0.3%. In the morning, it
looked as the Real Estate ETFs were going to break out, but they fell victim
to broad market weakness in the afternoon and closed below their breakout
levels. The two major ETFs that track the Real Estate markets are the iShares
DJ Real Estate Index Trust (IYR) and the iShares Cohen and Steers Realty
Majors (ICF). Looking at the daily chart below, notice how IYR rallied above
its prior highs on an intraday basis, but finished near the bottom of its
range:

We pointed out the Real Estate ETFs because that sector
showed the most relative strength to the broad market yesterday, but we also
wanted to convey just how difficult it is to be long in the current market
environment. Even when you pick the right sector, a difficult enough task in
itself, the selling pressure from the broad market is probably going to
prevent the sector from rallying in any significant manner. This is why we
simply follow the primary trend of the broad market rather than fighting it.
Just as water flowing down a stream will always follow the path of least
resistance, so too will the stock market. If there is more supply than demand,
stock prices will move lower, regardless of how much it may have
already fallen. Therefore, we hope you have been following our advice to avoid
the long side of the market or, at the very least, have been trading with
reduced share size and only on a very short term basis to play
counter-trend bounces. If you’re net short right now, the market is giving you
a lot of room for error with choosing the proper sectors and even the proper
timing. This is why it is always easier to profit from a stock market that is
trending steadily in either direction; you can make a few mistakes and often
still come out on top just as long as you are on the right side of the
market.

Taking an updated look at the S&P 500, the most notable
technical event is that the index failed to retrace more than 50% of its loss
from the May high down to the May low. We have illustrated this with Fibonacci
retracement lines on the daily chart below:

When an index reverses sharply after retracing less than
61.8% of its last move, odds are good that the direction of the primary trend
will resume. In this case, that means we are likely to see a test of the May
24 low within the next week or so. But more important is support of the
200-day

moving average.
It acted as support that triggered a broad market bounce last month, but a
subsequent close below the 200-day MA would be rather bearish and could
trigger heavy institutional selling. Because of these factors, we like the
risk/reward of selling short the S&P 500 SPDR (SPY). In hindsight, the most
ideal entry point would have been yesterday, but it would have also been a
riskier entry point before getting confirmation that the retracement in the
S&P was finished. Showing even more relative weakness than the S&P 500 is the
Dow Jones Industrial Average, which reversed yesterday after failing to
penetrate resistance of both its 20 and 50-day moving averages. DIA finished
only 0.3% above its closing low from May, so we now expect that prior low to
be broken over the next few days as well. If DIA slides below last month’s
low, expect it to quickly fall down to its 200-day moving average, which is
presently at 108.65 (10,867 on the Dow Jones).