TomAspray's  Instablog

Once the market bottoms, sector rotation could give rise to new market leaders, including a pair of sector ETFs that are now looking to rally off potential bottom formations.

Though some industry groups are outperforming the S&P 500, as tracked by the Spyder Trust (SPY), there are also quite a few that are acting weaker.

Some analysts are looking for the weakest industry groups to become the new leaders once the market finally bottoms out. The iShares PHLX SOX Semiconductor Sector Index Fund (SOXX) and the SPDR S&P Oil & Gas Exploration ETF (XOP) underperformed during the first-quarter rally and have been much weaker since the start of April. This makes these funds and their respective industry groups ones that should be watched closely.

Both funds reversed nicely alongside the stock market on Wednesday, but the volume and relative performance analysis needs to improve sharply to signal that an important low is in place. One looks attractive for a short-term trade, although longer-term investors should wait for more evidence before buying.

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Chart Analysis: The percentage change chart shows the relative performance of the iShares Barclays 20+ Year Treasury Bond Fund (TLT) and the Spyder Trust (SPY) along with the iShares PHLX SOX Semiconductor Sector Index Fund (SOXX) and the SPDR S&P Oil & Gas Exploration ETF (XOP) since the start of April.

• In less than two months, the difference in performance is striking, as TLT is up 9.9% while SOXX is down 14.8%, a difference of 24.7%
• XOP is now down just over 13%, and both it and SOXX have bounced from the lows last week, as XOP was briefly down more than 17% and SOXX 16.8%
• These two ETFs have been twice as weak as SPY, which is currently down just over 6%
• On the chart, also note that in early April, TLT (in pink) dropped below both SPY and XOP but surged back above them on April 5
• This resurgence was a positive sign and reflected the sharp improvement in the relative performance for TLT
• The relationship of SOXX and XOP to SPY should be watched closely for signs of a legitimate turnaround

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The iShares PHLX SOX Semiconductor Sector Index Fund (SOXX) retested the resistance from the spring of 2011 in the $60 area, line a, in March before turning lower.

• SOXX closed decisively below its uptrend (line b) last week. Next support is in the $46.60 area, which represents the lows from late last year
• In October 2011, SOXX traded as low as $43.54
• Relative performance, or RS analysis, dropped below its weighted moving average (WMA) in early April and has now broken more important support at line d
• Weekly on-balance volume (OBV) has also broken its uptrend, line e, and is below its declining weighted moving average
• XOP rebounded on Wednesday to close up for the day on the best volume seen in several weeks

The daily chart of the SPDR S&P Oil & Gas Exploration ETF (XOP) shows that the fund made marginal new highs on March 19 at $61.81, line f, before reversing to the downside.

• The break below the March lows at $57.64 completed the top. This level also acted as resistance in early May
• RS analysis formed a negative divergence in March (line i) when it did not make new highs with prices
• RS line completed its top on March 21 when support at line h was violated. The RS has continued to make lower lows and shows no signs yet of a bottom
• Daily OBV also formed a negative divergence at the highs (line k) and then broke important support (line j) in April
• Volume was heavy in early May, and the OBV has dropped to significant new lows
• The December lows at $48.38, line g, were broken last week
• Wednesday's daily reversal is a short-term positive sign with initial resistance now in the $52-$53 area

What It Means: Both of these oversold ETFs reversed from their early lows on Wednesday to close higher for the day. This suggests that a short-term bottom may be in place, and the volume did pick up on the buy side.

The relative performance analysis does not yet indicate that a sustainable low is in place, but a decent rally is now likely. A very strong rally could form the basis for a sustainable bottom formation.

How to Profit: Short-term traders could buy the SPDR S&P Oil & Gas Exploration ETF (XOP) at $49.06 or better with a stop at $46.93 (risk of approx. 4.3%). If longs are established, sell half the position at $52.26 or better for a 6.5% profit and raise the stop to breakeven.

Cancel the order if $50.40 is hit first or if this order if not filled by the close on May 25.

Technical weakness in four key global ETFs preceded, or even predicted, the current decline in the US market, making their latest price action especially crucial.

The early-April decline in the German DAX Index below the March lows was a warning to me that stronger world markets, including the US, also had the potential to violate their March lows.

Earlier this week, I was discussing relative performance (RS analysis), or what some refer to as "comparative relative strength analysis," with veteran trader and old friend Linda Raschke. She suggested that I also look at the recent action of some key global ETFs like the iShares MSCI Brazil Index Fund (EWZ), the iShares FTSE China 25 Index Fund (FXI), the WisdomTree India Earnings Fund (EPI), and the iShares MSCI Japan Index Fund (EWJ).

Linda's analysis of these funds last month confirmed her hypothesis that the US markets were also ready to move lower. For those looking to learn more about relative strength analysis, I think you will find this Webcast segment from Linda very informative.

Linda also shared some additional insights "When you want to trade the short side, pick the weakest. If the markets build a bit of a base and look poised for upside again, then you want to buy the relative strength leaders. If there is no confirmation from the other indexes, than the upside is not going to get very far. On this last selloff, all global indexes were making new momentum lows, so one could have traded the short side with added confidence."

These funds often lead the US market both lower and higher, and the relative performance analysis of the iShares MSCI Brazil Index Fund (EWZ) bottomed two months ahead of the US market in January 2009. Let's look at what these funds are telling us now.

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Chart Analysis: The weekly chart of the iShares MSCI Brazil Index Fund (EWZ) shows the rally from the October 2011 low at $49.25 to the high of $70.74 in early March. Through last Friday (May 18), EWZ has dropped 27.1% from its highs versus just an 8.8% decline in the Spyder Trust (SPY).

• If the October lows are broken, next good support is in the $44-$45 area
• RS analysis rebounded above its weighted moving average (WMA) late last year but failed to start a new uptrend
• The RS dropped back below its weighted moving average in March (line 1) and then dropped below support at line c. This was a sign of weakness and forecast an even more serious decline
• The RS line is in a clear downtrend and would need to move through its downtrend and above the March highs to turn positive
• Weekly on-balance volume (OBV) just tested its downtrend, line d, in March before dropping below its weighted moving average
• OBV made lower lows in October and was acting weaker than prices
• First strong resistance for EWZ is now in the $56-$57 area

The iShares FTSE China 25 Index Fund (FXI) reached a high of $40.67 in early February and was unable to make it much higher even though the US market continued to make higher highs.

• The break below support at $36 (line e) on May 9 completed the top formation and gave downside price targets in the $30-$31 area
• RS line failed to start a new uptrend while FXI was moving higher in early 2012, and it was unable to move above the October highs
• RS dropped below key support, line g, on March 17 (line 2), which was almost seven weeks before prices broke support
• RS line shows no signs of bottoming. Longer-term resistance is at line f
• OBV was stronger than prices in April, and the break of its support, line h, coincided with the price break
• The former support, line e, at $36 is now the first key level of resistance

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The WisdomTree India Earnings Fund (EPI) peaked at $21.59 on February 21 and is now down 26% from those highs. EPI is now very close to the late-2011 lows at $15.44. In 2009, the low was $8.81.

• RS analysis bottomed in January 2012 when the downtrend, line a, was overcome
• RS line stayed above its weighted moving average until February 24 and soon formed a pattern of lower lows
• RS line rebounded back to its now declining weighted moving average on March 13 (line 1). The daily downtrend, line b, is still intact
• OBV shows a similar formation, as it also peaked in February and has been weaker than prices since April, line c
• There is a band of resistance now in the $17-$18 area

The iShares MSCI Japan Index Fund (EWJ) gapped below support on April 4, which completed the daily top formation, lines d and e. EWJ is now down over 12% from the high at $10.21. A violation of weekly chart support in the $8.75 area would be much more negative.

• The RS line started to diverge from prices in early March when it made lower highs (line g) while prices were making higher highs
• In early April, the RS line broke support, line f, which was a negative sign and forecasted that prices would follow lower
• The RS is still in a well-established downtrend, line g
• OBV was much stronger than the RS, as it confirmed the price highs in late March and stayed above its uptrend, line h, until early May
• There is near-term resistance now in the $9.50-$9.70 area

What It Means: I generally use relative performance (RS analysis), or comparative relative strength, as a tool to find market-leading sectors, industries, or stocks. It is an important tool that can help you find the best places to invest, as well as those to avoid.

As Linda pointed out, it can also be a useful tool in supporting or contradicting other methods of analysis.

By April, the RS analysis of these four global ETFs had turned negative while the Dow Industrials, Nasdaq 100, and S&P 500 all continued to move higher. Each of these ETFs still look negative, which suggests that the decline in the US stock market will continue, although I do not expect to see the US indices drop as much as these ETFs.

How to Profit: No new buy recommendations at this time.

Portfolio Update: Buyers should be 50% long the ProShares Short S&P 500 ETF (SH) at $36.26 and 50% long at $36.06. Use a stop at $36.88 and sell half the position at $39.22 or better.

Some of the stocks in Warren Buffett's Berkshire Hathaway portfolio are now correcting near favorable entry levels where value- and income-minded investors can smartly buy in.

It is always interesting to look at the stocks that high-profile investment gurus like Warren Buffett are buying. Last year, however, was not a great year for Berkshire Hathaway (BRK.B), which was weaker than the S&P 500, losing 4.7%.

The weekly volume pattern in BRK.B does show some signs of accumulation, so 2012 could be a better year for Berkshire Hathaway. One of the stocks that Buffett bought more of in the first quarter, Bank of New York Mellon (BK), has had a rough two months and has dropped 16% so far this quarter.

Coincidentally, Buffett's top holding, Coca Cola Co (KO), is also the largest holding in my "Charts in Play" portfolio, and two of his other top holdings now also look attractive for new purchases.

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Chart Analysis: The Coca-Cola Co (KO) made a high in April of $77.82 but dropped to a low of $73.47 last week. KO currently yields 2.8%. It makes up 19.7% of Berkshire Hathaway's portfolio.

• The breakout in March above resistance at line a was very positive, and KO has retraced 38.2% of the rally from the January low at $6.56
• There is additional support at $72 (line a) along with the rising 20-week exponential moving average (EMA)
• The 61.8% support is now at $71
• Relative performance, or RS analysis, surged sharply on the breakout and shows a pattern of higher lows, line b
• On-balance volume (OBV) confirmed the breakout when it moved through resistance at line c. It is still well above its weighted moving average (WMA)
• Daily OBV (not shown) has dropped below its weighted moving average
• There is initial resistance now in the $75.30-$76 area

American Express (AXP) has corrected sharply from the recent high at $61.42 and has now dropped back to its rising 20-week moving average at $55. The stock makes up 11.6% of Berkshire Hathaway's portfolio.

• AXP broke through longer-term resistance, line d, in the $54 area last March
• The relative performance line also made new highs in April, which is positive. It has good support at line f
• Weekly OBV was also able to overcome major resistance, line g, in March
• Daily OBV (not shown) did confirm the recent highs but has now dropped back below its weighted moving average, suggesting the correction is not yet over
• Next resistance for AXP is in the $57.30-$58 area

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ConocoPhillips (COP) has dropped sharply from the high at $59.68 and hit a low of $50.66 last week. This is a drop of just over 15%. COP currently yields 5.2% and makes up 2.9% of Berkshire Hathaway's portfolio.

• The uptrend from the 2009 lows, line c, was broken last week, and there is further support, line b, in the $49.50-$50 area (line b)
• There is additional support now in the $48.50-$47 area
• RS line has pulled back to long-term support at line e, but it needs to move through resistance at line d to signal that COP is outperforming the S&P 500
• Weekly OBV dropped below its weighted moving average in the middle of April and is now back to good support at line g
• Daily OBV (not shown) turned negative in March and still has not bottomed out

What It Means: Since I am no expert in fundamental stock analysis, it is often helpful to look at the stocks that investing giants like Warren Buffett and George Soros are buying. I believe that looking at their picks from a technical standpoint can help identify good entry levels and also better control risk.

Since I have previously recommended Coca Cola Co (KO), I will not be doing additional buying for my model portfolio, but for those who are not currently long, I would still buy as suggested below.

Even though ConocoPhillips (COP) is still in a downtrend, the long-term positive outlook for crude oil prices and its very attractive yield make it look favorable on a test of stronger support.

Other major holdings of Berkshire Hathaway include International Business Machines (IBM), 17.8%; Wells Fargo & Co (WFC), 17.8%; and Procter & Gamble (PG), 6.5%.

How to Profit: For American Express (AXP), go 50% long at $54.62 and 50% long at $53.78 with a stop at $50.48 (risk of approx. 6.8%).

For ConocoPhillips (COP), go 50% long at $50.32 and 50% long at $49.58 with a stop at $46.88 (risk of approx. 6.1%).

Those not currently long Coca Cola Co (KO) could go 50% long at $73.58 and 50% long at $73.04 with a stop at $70.77 (risk of approx. 3.5%).