ETF: Sector Overview

Looking at an overview of sector charts, the overall market orientation is quite bearish. After Friday’s countertrend rally, many charts are providing advantageous entries on the short side. While the bearish case appears compelling, the current and future administrations are both working to provide economic solutions. Therefore, before we get too aggressive shorting stocks, it is worth reflecting on potential game-changers.

Friday’s rally was apparently triggered by the announcement that President-Elect Obama will nominate Timothy Geithner as Treasury Secretary. Personally, I think the selling had dried up, and the market was looking for just about any reason to rally. Let’s take a look at the Oil Services HOLDRs ETF (OIH) two day chart:

After Thursday’s brutal day of selling, OIH spent most of Friday consolidating in a narrow range. After the Geithner announcement, OIH broke above this range, and we saw a big short squeeze.

On the plus side, Obama appears to be taking some genuinely positive steps on the economy. First, Geithner looks to be a solid choice at Treasury. From The Economist:

First, he represents continuity. From the first days of the crisis last year, he has worked hand in glove with Ben Bernanke, the Fed Chairman, and Mr Paulson. He can continue to do so while awaiting confirmation. If Citigroup, for example, needs federal help, Mr Geithner will be involved. An unknown when he joined the New York Fed in 2003, he is now a familiar face to the most senior executives on Wall Street and to central bankers and finance ministers overseas.

Second, he represents competence. He has spent more time on financial crises, from Mexico and Thailand to Brazil and Argentina than probably any other policymaker in office today. Mr Geithner understands better than almost anyone that in crises you throw out the forecast and focus on avoiding low probability events with catastrophic consequences. Such judgments are excruciating: do too little, and you undermine confidence and generate a bigger crisis that needs even bigger policy action. Do too much, and you look panicked and invite blowback from Wall Street, Congress and the press. At times during the crisis Mr Geithner would counsel Mr Bernanke on the importance of the right “ratio of drama to effectiveness”.

In normal times, risk aversion damps economic cycles; in a crisis, it accentuates them, leading to withdrawn credit, evaporating liquidity, margin calls, falling asset prices, and more risk aversion. “The brake becomes the accelerator,” as he puts it. Indeed, although he worked alongside Mr Paulson on the crisis, he has at times advocated a more aggressive approach. For example, news reports say that he was not comfortable with Mr Paulson’s decision to take public money off the table in the ultimately unsuccessful effort to save Lehman Brothers. He has not always got it right: he was the key architect of the original bail-out of American International Group, the insurer, which in time has proved flawed, requiring significant amendment.

Second, Obama is focusing much needed attention on economic stimulus at the grassroots level, including investment in the nation’s infrastructure. In the short run, however, none of these actions are likely to have a significant impact on stock market direction.

The game-changer, at least in the short-term, could come from the SEC. On Monday, the SEC will host a “meeting with international regulators to examine whether new regulations in the U.S. and other countries seeking to stop abusive short-selling practices have been effective.” I take this to mean that additional short-selling restrictions are probably not imminent, but are under consideration. At the same time, this is a situation to monitor closely. While an outright ban on short-selling is counter-productive, and impairs market participants, reinstating the uptick rule would seem to be a logical action. Any significant SEC action to restrict short selling is likely to produce a big rally, considering oversold conditions.

Looking at index and sector charts, we see that Friday’s rally has moved price toward prior breakdown levels. Charts across the board are in steep downtrends, and face considerable overhead resistance. There is some room for optimism in the charts for iShares FTSE/Xinhua China 25 Index (FXI) and iShares MSCI Emerging Markets Index ETF (EEM) (see the end of this post).

- SPY (SPY) has big resistance around 83.40.

- iShares Russell 2000 Index ETF (IWM) actually rallied on increased volume. I could see us continuing the rally on Monday, and would be getting more aggressively short around 44.30.

- QQQQ (QQQQ) rallied on slightly decreased volume, and will start hitting resistance around 28.00.

- DIA (DIA) rallied on very heavy volume, and is already at resistance. I will be watching this one closely.

- US Dollar Index Bullish (UUP): The US dollar ETF is still trending higher, and remained firm despite a very bullish day for gold. At this point I am still considering the dollar to be bullish, and commodities to be deflationary.

- SPDR Gold Shares ETF (GLD) had a strong day, bouncing off of resistance with volume. This is still a bearish chart overall.

- United States Oil (USO): Oil prices are still going down.

- OIH bounced on heavy volume, but is going to hit resistance very soon.

- Market Vectors Steel ETF (SLX): This is a very bearish chart.

- XLB (XLB): The materials sector, like oil and steel, broke the October low, and is now moving up into resistance.

- XLI (XLI): The industrial ETF rose on increasing volume, and is now at resistance.

- Financials Select Sector ETF (XLF) formed a hammer on slightly decreasing volume. Maybe we get a little bounce here, but nothing good is happening in this sector. Beware of potential short selling restrictions.

- Real Estate ETF (IYR): Oversold, but things look bleak here.

- KIE (KIE): The insurance ETF is one of my favorites as a potential short.

- FXI (FXI) looks about as bullish as anything among the ETF’s I track. We have a higher low in place, and Friday’s move was on very high volume. Look for a break above the 50 day moving average and a higher closing high.

- EEM (EEM) broke the October low with volume, and then rallied back above that level with similar high volume. While this is still a bearish chart, I would not be short EEM here.

I will be working on a watchlist for specific stocks to be posted by Monday morning.

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