Market
Commentary:
Let’s
talk about market leadership and examine it closely
now that we have had a few days of 2006 to measure.
The
basic theory here is that market leadership will
help us quantify how investors are perceiving risk.
If the OTC is leading the charge investors are
viewing risk favorably.
If
the OTC is lagging and failing to provide leadership,
investors perceive risk to be a threat in their
buying patterns.
I
have three measures to help quantify market leadership
and you can see these indicators by visiting our
indicator page on the website.
The
first measure is the Dominant Market relative strength
ratio. This compares the OTC, which is tech driven
verses the NYSE which tends represents larger companies.
There are a lot of energy companies in the NYSE.
If
you look at this chart today, despite this powerful
rally in the OTC, you will find this ratio is still
negative. This is because the energy stocks have
actually outperformed the OTC stocks in the first
few days of 2006.
For
example, not counting today, Fidelity Select Energy
Service is up 10.18% YTD compared to Fidelity Select
Electronics which is up 8.44%. What this means
is that investors have also been buying energy
stocks with great enthusiasm.
Crude
oil prices have been climbing sharply, jumping
from $57 a barrel to $64. Iran has been undeterred
by UN threats about nuclear development. And with
the stroke of Ariel Sharon investors have been
hedging their bets that we could see either Israel
or the U.S. move toward an attack on Iran’s
nuclear sites if Iran doesn’t back down.
Iran
is preparing for war and it certainly wants crude
oil prices as high as it can get them, so this
problem of high oil prices doesn’t seem to
be going away. In any case, Energy is outperforming
Technology in the early days of 2006, but not by
much.
It
is surprising that the OTC is even close in performance
considering the sensitivity of OTC investors to
geopolitical risk and rising crude oil prices,
but it is. However, the higher crude oil prices
go the more it poses a serious challenge to the
technology-driven OTC. Oil tested $65 a barrel
today, a touchy neighborhood for OTC leadership.
Right now the NYSE is still leading the OTC – a
mixed signal.
The
second measure of market leadership that I use
is the McClellan Volume Summation OTC. This measures
how much volume is supporting the OTC. I use a
7-day moving average against a 13 day moving average.
Yesterday, this indicator turned positive. This
indicator has been rather volatile recently, having
turned positive in early November, going negative
in mid-December and now positive again. So, clearly,
sector rotation has been extremely wild the last
few months, to say the least.
However,
it is positive now and as long as it remains this
way, it tells us investors are supporting the OTC
with volume in addition to price – favorable
and bullish. What we don’t know is how long
this will last. The market is short-term overbought,
with %K at 98 and %D at 90. What I would like to
see is if this indicator can remain positive through
the next short cycle correction. If it can, I am
prepared to allocate a portion of our sector portfolio
into the growth sectors again.
The
third measure I use is the Microcap mutual fund
average. This takes all of the microcap mutual
funds that I know of and creates an average of
this group. What I like to see is the 10-day average
trending above the 30-day average. Understand that
this group measures small companies with most of
these managers taking a small cap value approach.
This measure is looking very strong, so investors
are clearing buying small cap value stocks and
looking very bullish.
In
summary, two of the three market leadership indicators
are positive and if market leadership remains so,
I will be looking to invest in growth on any short
cycle pullback.
On
the other hand, I see the same scenario for energy
stocks. Short cycles for crude oil are highly overbought
and looking near a top. Short cycles for oil have
just turned negative with %K at 80 and %D at 83.
There is a wild card here – Iran, an affair
that is certainly providing support and impossible
to predict.
Frankly,
I don’t trust the ability of the OTC growth
sectors to sustain upward leadership as long as
crude oil prices continue to climb. But the indicators
are turning positive and that is simply amazing
considering soaring crude oil prices are also along
for the ride.
In
the short-term, the market is extended. I look
for a consolidation to adjust this condition in
the near term. I think it is prudent to wait for
a pullback before committing any further funds,
especially ahead of the FOMC and OPEC meetings
at the end of this month.
