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January 16, 2007

Oil and Earnings...
by Mark McMillan

Index Advisor 004
1/16/2007 9:25:00 AM

Recommended Trades:

We need to wait for a reversal to enter a trade here.

Open Positions:

We closed our short position in the SPYders (Amex:SPY) at $141.40 in the final hour of trading on Wednesday, January 10th.

Overview

Trading action in the last week has reversed the weakness seen in recent weeks. All major indexes moved sharply to the upside, with the NYSE issues outpacing NASDAQ issues.

Alcoa kicked off earnings season with a positive report. The coming week has a lot more heavy hitters reporting, so trading should be dominated by reported earnings and, more importantly, forward looking guidance.

Oil has dropped from above $60.00 at the end of 2006 to below $53.00 by Friday. Oil hasn't yet dipped below $50.00, but there is now talk about that occurring. With Oil prices dropping, a large contributor to inflation is being mitigated. While this adversely affects the earnings of oil companies, it lowers costs for many/most of other companies, and lowers the costs for consumers to fill up their gas tanks.

At this time, the soft landing scenario seems to be the consensus. Housing and the automotive industry haven't had enough negative effect to offset corporate earnings and now the tailwind of reduced energy costs.

To understand more about our view on the markets, we will have to look at the charts.

Market Climate

The market finished with a significant push upward last week, with a bit of weakness in the early part of the week, but then finishing the week quite strong.

Once again, the Index ETFs are showing signs of accumulation by investors. While we believe that the soft landing scenario could continue to unfold, investors should be wary, as the market appears to be ready to react to negative news. We say this because with the significant fall in the price of oil propping up the markets, there has been a less than commensurate move upward. Anything that moves energy prices the economy, etc. will likely see an over reaction as investors head for the exits and take profits.

The U.S. stock market composite chart:

Last week's failed move downward resulted in a bounce off of the 50-day moving average and a climb through the week. However, RSI weakened late in the week as did volume. While the rally was strong, it appears that conviction may be lacking on the part of bulls to push the market higher, without receiving more good news on corporate earnings.

We will examine the charts for all three major indexes in multiple timeframes to determine alignment for a consistent move in a single direction. We will first look at weekly, then daily, and finally hourly charts for the indexes.

Now, let's take a look at the charts for the major indexes.

A look at the weekly chart for the Dow Industrials is represented by the Diamonds ETF (Amex:DIA).

Abbreviations and color key appears below:

Note the following order is Red, Yellow, Green, just like a stop light, so it might be a helpful mnemonic:
Thick Red line represents the 200-day simple Moving Average, (200DMA)
The yellow line represents the 50-day simple Moving Average, (50DMA)
The green line represents the 20-day simple Moving Average, (20DMA)
The light blue line represents the 3-day Moving Average, moved forward three days in time, (3x3MA)
The thick blue line indicates the exponential 13-day Moving Average (13DMA)
Bollinger Bands are abbreviated as BB. There is an upper and a lower Bollinger Band that varies in distance from a central moving average (shown as light red/pink) based on the volatility of stock price movements.
RSI stands for Relative Strength Index. It is an oscillator, which can be used to determine how overbought or oversold a stock may be.

A look at the daily chart for the Dow Industrials is represented by the Diamonds ETF (Amex:DIA).

A look at the hourly chart for the Dow Industrials is represented by the Diamonds ETF (Amex:DIA).

In examining the three charts together, it appears that a consolidation or a reversal is more likely than a continuation of this rally. We would key off of the 60-minute chart indicating the start of a downtrend when ROC crosses definitively below zero, along with a clear reversal in the upward movement of price on the daily chart with the choppiness indicator starting to move downward from its position of readiness to start a new trend.

We will suggest a short trade in this instance, but we aren't there yet.

The S&P 500 ETF, known as the Spyders (AMEX:SPY) is shown in the weekly chart below:

The S&P 500 ETF, known as the Spyders (AMEX:SPY) is shown in the daily chart below:

The S&P 500 ETF, known as the Spyders (AMEX:SPY) is shown in the hourly chart below:

The charts for the SPYders show conflicting underlying indicators. The shortest term hourly chart shows the uptrend may be tiring. The daily chart looks like a breakout of the sideways trading range is imminent, and the Fractal indicator suggests the next move will be a strong trending one. The weekly chart offers little guidance as to market direction at this time.

Our bias is to the upside, but the market hasn't yet tipped its hand. We will have to watch the markets early in the coming week to commit to a trade either way.

This week's NASDAQ 100 ETF (QQQQ) Weekly Chart is below:

This week's NASDAQ 100 ETF (QQQQ) Daily Chart is below:

This week's NASDAQ 100 ETF (QQQQ) Hourly Chart is below:

Examining the three charts for the QQQQs, we take away a clearly bearish bias. While the weekly may see a break back up and through the medium term uptrend line, the daily chart shows Friday's trading reached an important Fibonacci level and the uptrend may be tiring. The hourly chart also shows indicates a downward move may be getting started with ROC nearing 0. The daily chart shows ROC at a likely reversal level, which doesn't mean price has to follow immediately, but with the other evidence, we would not recommend going long the QQQQs at this time and would be poised to short the index soon.

Conclusion:

We believe the coming week will mark a change in the uptrend. If not beginning a tradable reversal, we believe the markets will consolidate this week. The QQQQs and DIAmonds look set for downward moves, while the jury is still out on the S&P-500.

This coming week begins to see a heavier stream of companies reporting earnings, while the following week will see an even heavier stream of reports. We are particularly concerned over the effects of companies taking down forward guidance. Investors are quite nervous at this time and this could result in a fair amount of profit taking.

Regards and Good Trading,

Mark McMillan
Fundamental Trader Alert

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