Thursday, March 13, 2008

Technical Thursdays: A Non-confirmation Low in the Works

There are a number of fairly positive technical indicators that have the potential of giving a buy signal sooner rather than later – in time for a good spring rally.

Most of the indicators fall under the divergences principle*. The three charts posted are examples of what an investor might be on the lookout for.

The first chart is the granddaddy of all divergences principle – the Dow Theory. What may have gone unnoticed is the fact that when the Dow Industrials broke below their January lows earlier this week, the Dow Transports did not. The second chart helps probe a little further into why this was the case.

The second chart illustrates the primary components of the Dow Transports ETF – IYT. Weakness in Overseas Shipholding Group (OSG) has been more than overset by strength in Ryder (R), CSX, Burlington Northern (BNI), and Norfolk and Southern (NSC).

Note: From a fundamental perspective, BNI, for example, is projected to produce solid growth numbers this year. Moreover, doesn’t some guy from Omaha have a fairly large stake in BNI?

The third chart covers the beleaguered Financials sector. What I have added to the group are the Homebuilders ETF – XHB – given its ties to the financial crisis. The first thing that jumps out from this chart is how the credit crisis has migrated from the homebuilders to the broker dealers (IAI) and insurance (IAK). What seems to be key in this grouping is to watch for any signs of relative performance strength or at least an equaling of performance vis-à-vis the broad market (S&P 500). Should some level of price performance stability or no worse than even market performance develop, then the downward pressure exerted by Financials would diminish and, thereby, reduce the downward pressure on equities.

Investment Strategy Implications

Should the broad equity market indices break to a new low, the potential for a major non-confirmation exists. Now let's add a new low in the US dollar and Gold trading well above $1,000 an ounce. If all three factors occur, it is more than reasonable to assume that a general level of investor fear would set in with talk that the Fed is impotent (Can you hear it now: "If hundreds of billion of dollars can't turn stocks around, nothing will."). Accordingly, all of the above should set the stage for the capitulation phase to this mini bear/correction (see Tuesday’s blog).

Investor psychology is quite fragile. The stuff of capitulation and non-confirmation lows.

*See prior blog entries and reports for definitions and examples
**click images to enlarge

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