This ETF is showing relative strength

After trading in a sideways range
throughout the morning session, stocks
attempted to rally at mid-day, but sellers stepped in during the final two hours
and quickly caused most intraday gains to evaporate. Both the S&P 500
(
SPX |
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and Nasdaq Composite
(
COMP |
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Dow Jones Industrial Average
(
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was in the small and mid-cap arena, where those market segments showed relative
strength to the broad market. The small-cap Russell 2000 Index advanced 0.3%,
while the S&P Midcap 400 gained 0.9%. Still, it was a relatively uneventful day
overall. For the week, the S&P 500 lost 0.6%, the Nasdaq Composite 0.4%, and the
Dow Jones Industrials 0.2%.

Total volume in the NYSE declined by 3%, while volume in the
Nasdaq was 6% lower than the previous day’s level. It was the second straight
day of declining volume and the fifth consecutive day in which turnover came in
below average levels. Given that the major indices were stuck in a narrow
trading range throughout last week, it makes sense that volume levels dropped
off as well. However, the broad market’s recent price to volume relationship has
been on the positive side. The S&P 500 closed lower in four out of five days
last week, but volume declined in each of those four sessions. Conversely, the
S&P 500 was accompanied by higher volume on the sole day in which the index
closed higher (June 21). Given that most of the market’s numerous “down” days
over the past seven weeks have been on higher volume, it was bullish to see the
lighter turnover in each of the S&P’s four losing days last week. Nevertheless,
price action has not yet confirmed the moderately bullish shift in the volume
patterns.

In the June 23 issue of
The Wagner Daily, we
illustrated that both the S&P 500 and Nasdaq Composite were sitting at pivotal
“make it or break it” levels that would soon force a significant move in one
direction or the other. Since prices of both indices were nearly unchanged in
Friday’s session, the technical picture remains the same going into today. To
refresh your mind, take another look at the daily charts of both the S&P 500 and
Nasdaq Composite:

As you can see, both the Nasdaq Composite is running into
resistance of its primary downtrend lines, while the S&P will soon do the same.
This will inevitably cause the market to soon “show its hand.” Further,
volatility has dried up over the past week, causing the major indices to coil up
like a spring. The longer this volatility contraction continues, the more
powerful the move will be when it eventually comes. The big question, of course,
is which direction that move will go. Unfortunately, the market is now giving us
mixed signals. The bullish argument is that volume patterns have begun to show a
decline in institutional selling and increased demand on the sporadic “up” days.
It is also positive that the major indices are still holding above their lows
from the June 21 rally. Conversely, the bears can simply point to the fact that
the seven-week downtrend lines remain firmly intact. The longer a trend has been
in place, the more likely the trend is to continue.

One ETF that has been showing relative strength to the broad
market is an international ETF called the iShares Xinhua China 25
(
FXI |
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PowerRating). For
those of you who are not familiar with it, FXI mirrors the price of mainland
China’s Xinhua 25 Index, their equivalent of our large-cap Dow 30 Index. Note
that all the companies in the index are mainland Chinese shares, not those of
Hong Kong or Taiwanese companies. Although the S&P and Nasdaq both remain below
their seven-week downtrend lines, notice how FXI has already broken out above
its equivalent downtrend line:

Unlike the S&P and Nasdaq, FXI is also sitting above its
200-day moving average, which is one less obstacle to overcome on any further
rally attempt. If the major indices in the U.S. markets begin to break out above
their downtrend lines, you can expect FXI to outperform those indice on the way
up. However, FXI is also likely to lose a lower percentage if the U.S. markets
head back down to their prior “swing lows.” It may be a bit aggressive to take a
position in FXI without confirmation from the U.S. markets, but we definitely
recommend putting FXI on your shopping list as an ETF to buy when/if the S&P and
Nasdaq break out above their downtrend lines.

Because of the market’s mixed signals and the close proximity
of the major indices to their downtrend lines, an extra ounce of caution is
required over the next several days. Our near-term bias has also shifted to
neutral, so you essentially have two options that make sense — remain on the
sidelines, fully invested in cash and ready to strike when the moment is right,
or position yourself on both sides of the market. The latter scenario
reduces your overall risk by hedging your bets, but also requires the ability
and willingness to quickly cut losing positions on the wrong side of the market
after stocks establish their next major direction.

Open ETF positions: