Monday, July 07, 2008

Three Themes I'm Tracking in the Stock Market

Is the stock market likely to take out its previous day's highs? Are we likely to test or break the prior day's lows? These are the questions I typically ask during the opening minutes of trading. As the day unfolds, I watch short-term sentiment (NYSE TICK, Market Delta) and the behavior of various market sectors to handicap the odds of making various moves during the day.

Lately, much of the odds have boiled down to whether the market is trading in what I call "recession mode" or "recovery mode". In recession mode, there is risk-aversion among stocks; in recovery mode we see bargain hunting among the hardest hit sectors. The three themes I've found most helpful in tracking these modes are:

* Performance of the Financial Sector Relative to the Broad Market - I look at the banking sector ($BKX), the S&P 500 financial sector (XLF), and individual stocks that have been vulnerable (LEH, MER, C, FNM). When the financial stocks are weak, the market is in its risk-averse, recession mode and I anticipate selling in the broad market;

* Performance of the Housing Sector Relative to the Broad Market - I look at the homebuilders ($HGX), but also regional banks (KRE), as those have exposure to loans to struggling housing developers. When the housing sector is weak, the market is risk-averse and anticipating further recession.

* Performance of Consumer Staples Sector Relative to the Consumer Discretionary Sector - When the market is anticipating recession and in its risk-averse mode, we see money going into the more recession-resistant staples stocks (XLP) and away from the discretionaries (XLY).

Today all three themes kicked into their risk-averse, recessionary modes. That was a great tell for the day's direction. I suspect these themes will also help us identify any eventual turnaround in this weak market. As long as traders and investors anticipate further bad news and losses from banking and housing, however, they will stay defensive--and that poses pressures for the rest of the stock market.
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