Pullback A Healthy Sign For Stock ETFs

March 28, 2009

The market needs a breather at this point, says strategist. He warns investors against putting too much stock in a three-week rally.

 

The S&P 500 pulled back a bit on Friday. But volume on major stock exchanges was relatively low, which is actually a healthy sign.

In fact, we'd like to see the blue chip index fall to around the 750-790 range in coming weeks, from the current level of 820.

The current rally, which started on March 6, has just come too far in too fast of a time frame. It has been a fairly broad rally, though. If the month ended right now, we'd be looking at the best monthly returns since 1974. In the past three weeks, the S&P 500 index has jumped 22.4%.

While that's great, it's more constructive at this point to have a moderate retracement. That doesn't mean we need to see the index retest the 666 mark, its 12-year low. But even a pullback of some 8.5% to 750 would still provide support for a longer-term rally.

Running Out Of Steam

If stocks continue to climb, technical factors indicate that the S&P 500 will hit considerable resistance at the 875-880 range. That would represent about another 8% rise from current levels.

Today, some 70% of stocks on the New York Stock Exchange have moved above their 50-day moving average. Again, that indicates the market has moved too far and too fast. Look at Jan. 6, when 80% of stocks were trading above their 50-day moving averages. The result was a sharp correction to multiyear lows.

So from a technical perspective, the safe move for a broad-based fund such as the SPDRs S&P 500 ETF (NYSE: SPY) would be to wait until it's trading around $75 a share. It closed on Friday at $81.59. So we're looking for about an 8% fall to signal a more reasonable entry point.

The same reasoning holds for the PowerShares QQQ (Nasdaq: QQQQ). The Tech-heavy ETF closed at $30.82 per share on Friday. Technically speaking, a better entry point would be $28 per share. On Oct. 24, 2008, the ETF hit a low for this current cycle at $28.09. From early December 2008 through the end of February 2009, its low range was right around $28. And QQQ's 20-day moving average is right at that point now.

Another note of caution is that the market rose 6.2% last week—the first time we've seen three up-weeks in a row in almost a year. Although that's pretty good, it still isn't enough to guarantee that this rally is a new bull market.

Searching For New Leadership

Typically, lagging sectors that lead markets down aren't the same ones to lead us out of a bear. And Financials, the leader of the bear market, was the best sector this week, advancing 12.2%. Industrials, as represented by the Industrial Select Sector SPDR (NYSE: XLI), rose 10.5% on the week. That was another laggard that now has quickly become quite popular.

The old saying applies here—you don't fight new wars with old generals.

So who are the new leaders? One area could be alternative energy and solar. Last week, China announced it would subsidize those industries. As a result, funds such as the Claymore/MAC Global Solar Energy ETF (NYSE: TAN) and the Market Vectors Solar Energy ETF (NYSE: KWT) soared on extremely high volume. (That's a strong indicator of institutional support.)

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