Watch the BBH, here’s why

Stocks shook off mid-day weakness to
close mixed yesterday, at least temporarily putting the brakes on the
broad market’s recent slide. The S&P 500
(
SPX |
Quote |
Chart |
News |
PowerRating) and Dow Jones Industrial
Average
(
DJIA |
Quote |
Chart |
News |
PowerRating), both down approximately 0.5% at their intraday lows, closed
higher by 0.3% and 0.4% respectively. The Nasdaq Composite
(
COMP |
Quote |
Chart |
News |
PowerRating) finished
lower for the fifth consecutive day, but only by 0.2%. Small and mid-cap stocks
continued to show major relative weakness, as both the Russell 2000 and S&P
Midcap 400 indices lost 0.6%. The small-cap Russell 2000 has lost nearly 5% in
just the past three days, but this is not surprising because it is also the
index that showed the most relative strength when the market was bullish.

Total volume in the Nasdaq was 12% lighter than the previous
day’s level, indicating that institutions took a break from the recent
distribution of stock. Volume in the NYSE was about the same as the prior day.
Despite lower turnover in the Nasdaq, market internals were still negative.
Declining volume in that exchange exceeded advancing volume by more than 2 to 1.
Regardless of a slightly higher closing price in the S&P, the NYSE internals
were negative as well. Declining volume was heavier than advancing volume in the
NYSE by a margin of just under 3 to 2.

When a strong, uptrending market corrects sharply off its
highs, the industry sectors that were previously showing the most relative
strength are often the ones that correct the largest percentage. At the same
time, institutional money flow out of those sectors often goes directly into
some of the formerly "beaten down" industries that lagged when the broad market
was strong. Although the market has lacked clear sector leadership since the
broad market selloff began on May 11, we have begun to see moderate signs of
institutional sector rotation that has led to pockets of industry strength.

Oil, Gold, and Metals, three industry sectors that have been
outperforming the broad market for many months, have each corrected sharply over
the past several days. Since May 10, the S&P 500 has lost 2.1%, but the Oil
Index
(
XOI |
Quote |
Chart |
News |
PowerRating) has slid 5.4% during the same period. We covered half of our
short position in the S&P Energy Sector (XLE) for a 5% gain yesterday. The Gold
Index
(
GOX |
Quote |
Chart |
News |
PowerRating) has plummeted a whopping 12.6% over the past three days! Because
institutions such as mutual funds typically have bylaws that dictate they must
be fully invested in the market at all times, where has all of the institutional
outflow of these sectors gone? The answer may lie in the healthcare-related
sectors, which began to show pretty decent strength yesterday. The S&P Select
Health Care SPDR (XLV) outperformed with a 1.4% gain yesterday, the
Pharmaceutical HOLDR gained 1.8%, and the Biotech HOLDR
(
BBH |
Quote |
Chart |
News |
PowerRating) advanced 1.9%
(reference the

Morpheus ETF Roundup for a list of other ETFs in the same sector). Of these
three, BBH is the only one that is nearing a clear technical entry level on the
long side. Although it has been in a steady downtrend since November of 2005, it
appears that BBH is trying to put in at least a short-term bottom:

While the broad market has steadily dropped over the past
three days, BBH has traded sideways to higher. The Nasdaq Composite has lost
3.5% over the past three days, but BBH has gained nearly 1% during that same
period. As such, it can be said that BBH (and the biotech stocks in general)
have begun to show relative strength. We obviously don’t know how long the
relative strength will last, but sectors that are outperforming the broad market
are always the safest ones to be long in a weak market. If the market continues
lower, BBH is likely to fall less than other sector ETFs. Conversely, it should
be among the first sectors to rally when the broad market bounces. As regular
subscribers will note below, we are looking to buy BBH on a rally above its May
9 high. We are also stalking a couple of weak sectors for short selling
opportunities, but are patiently awaiting the proper entry point to sell short
on a bounce into resistance. If stocks bounce today, we will highlight a few
sectors we like on the short side in tomorrow’s Wagner Daily.

As mentioned yesterday, we feel that short selling should now
be concentrated in the S&P and Dow-related sectors due to the Nasdaq trading
near major support levels. Specifically, the Nasdaq closed right at its 200-day

moving average
yesterday and is still holding support of its 2006 low, albeit not by a wide
margin. The best looking broad-based ETFs for short selling are the Russell 2000
(IWM) and the S&P Midcap 400 (MDY), although we would ideally like to see a
bounce in both of those today before entering a new short position in either
one. A retracement back up to the 50-day MA in IWM would present an ideal
risk/reward level for short entry.