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A description of the content follows : Have the bulls already worn out their welcome, and invited the pullback so many are assuming is already on the way? The chatter says yes, but the data says no. The reality of the rally's longevity is below. After that, a handful of sector and industry calls. 'Nuff said. First though, we want to direct...

 
 
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The Micro Cap Press - Discover the Power of Early Stage Growth
Thursday, September 9, 2010 @ 6:01 am PDT Volume IV : Issue 38
In This Edition...

Have the bulls already worn out their welcome, and invited the pullback so many are assuming is already on the way? The chatter says yes, but the data says no. The reality of the rally's longevity is below.

After that, a handful of sector and industry calls. 'Nuff said. 

First though, we want to direct you to a recent blog entry that's chock-full of information you need, but information you probably don't have.... stock valuations and growth rates at the sector level. Let's just say not all is as it seems if you're looking at P/E ratios alone. You can get the whole scoop by reading "Sector Valuations.... What 'Should Be' Versus What Is.
 

Bulls Not At the End of the Line Yet

Though the market's breadth and depth have been the focal points for the bulk of our recent market timing commentary, they aren't the only tools we keep in the arsenal. Though discussed less often, we make equal use of sentiment indicators..... indicators that tell us where the market is in the peak/valley pattern that we can ultimately use to time entries and exits. 

More importantly, one of the current sentiment tools suggests there's actually room for quite a bit more bullishness from the market

Along the same lines as the VIX (S&P 500 Volatility Index) or one of the Rydex-based (Nova and Ursa funds) sentiment ratios, the number of put options traded in comparison to the number of call options traded for any given day can tell us a great deal about what the aggregate market is thinking. Like all the other sentiment tools, the key to a trend's longevity is a balance of those two numbers, while reversals tend to occur when the imbalance hits one of the extreme ends of the spectrum. 

Clear as mud? Don't worry - we've got an example. 

Simply stated, put/call ratios indicate net bearish or bullish opinions, in that the greater the number of out options bought, the more bearish investors are thinking. Conversely, the greater the number of calls that are traded, the more optimistic investors are. 

A put/call ratio can be calculated in a lot of different ways, like by the exchange (CBOE, NYSE, etc.), by the type of underlying security (equities, or indices too), and even by index constituents (like the S&P 500's stocks). By and large, however, all those put/call ratios move in tandem, peaking and bottoming at the same time. 

Just because it's one of the biggest and broadest, we tend to focus on the NYSE's put/call ratio; this is what appears along with the S&P 500 on the nearby chart. This same chart also illustrates just how beneficial such a sentiment tool can be. 

Though not this perfect over the long haul, all of the major short-term swings for the market began when the NYSE put/call ratio was at an extreme reading, as indicated by a brush with its Bollinger bands (blue). Each type is marked on the chart with an arrow (green = bullish, red = bearish)

Like we said, it's not usually this cut and dried. Even at a fraction of the accuracy we've seen from the NYSE put/call ratio's peaks and troughs at spotting market reversals though, we'd be crazy to ignore the data. Better still, when combined with other market timing tools like breadth and depth, proper sentiment analysis can lead to ridiculously effective market timing

Anyway, we don't bring the strategy up to sell you on the idea - we bring it up to point out that despite the market's recent strength, the put/call readings are still quite tame...nowhere near an extreme low that tends to flag a short-term top. We really won't need to worry until the NYSE put/call ratio falls to the low 60's, where the lower Bollinger band is now. We can afford to remain bullish in the meantime. 

We're going to check in on this put/call ratio chart from time to time along with our other timing tools. Though short-term in nature, the long-term war is won with short-term battles. 
 

Sector/Industry Calls

Though bullish in the short run, in the grand scheme of things the market is still in limbo... and it's likely to keep most sectors and industries locked into the same listlessness until the bulls or the bears can break us out of the rut. There are a handful of industry indices, however, that appear to be moving well enough on their own that they don't need the market's help. Of course, not all of these independent trends are bullish. Here's a look at the more trade-worthy ones. 

Pharmaceuticals 

This rally has largely been of the radar for a couple of reasons, the first of which is that the selling efforts since May have been able to attract a lot more attention than the buying effort of the pharmaceutical group has. The second reason this was a stealth rally - the gains have been so modest, nobody really cared (or cares).... except us

While rapid gains would be nice, reliable gains will work just as well. And as you can see on the nearby chart of the S&P 1500 Pharmaceutical Index, higher highs and higher lows have been reliable since late May. 

The bullish clincher from here would be a move back above the 100-day moving average lie at 297. 

Managed Care 

While not as consistent as the rally we've seen from the pharmaceutical industry's stocks, the S&P 1500 Managed Healthcare Index has done one thing the pharma index - nor most indices - haven't been able to do lately.... move above its 100-day moving average line. Even without the milestone move though, the group has been in a strong uptrend since early July. 

Though the onset of a sweeping overhaul to the healthcare system was the underlying reason for the big pullback, as the dust continues to settle, the most dire (and overblown) assumptions about the President's reform law are dissipating. What remains are several single-digit P/E stocks (past and projected) that aren't nearly as threatened as first thought. 

Gas Utilities 

Considering how well the overall utilities sector has been doing of late, it's a bit of a surprise to see any of its constituents doing poorly. One of them is though.... gas utilities. And more importantly, given the shape of its chart, odds are good things will get worse for these stocks before they get better. 

The key problem here is the recent cross of the 100-day average line under the 200-day average line, though the underlying problem is more fundamentally-based. With demand for power starting to taper (already short of expectations) on top of deteriorating natural gas prices, there's not a lot to look forward to. Thing is, neither of those conditions is anticipated to change anytime in the foreseeable future. 

Household Products 

Think household products and consumer staples stocks are a safe place to hide when things get rough for the market? Think again. No sector or industry is immune to drawn-out selloffs. Take a look at the nearby chart of the S&P 1500 Household Products Index. It started to fall apart in late March, and hasn't been able to come up for much air since then. The bears don't appear willing to let go anytime soon either. 

And here's the really crazy part.... these stocks probably deserve to be sold some more, since they're overvalued as is. 

Like we pointed out on Tuesday, the consumer staples sector is only apt to foster slow growth over the next four quarters (6.8%). No big deal, but with a trailing twelve-month P/E of 14.7, that translates into a hefty PEG ratio of 2.67 - well beyond what most investors would consider acceptable. 

As always, we'll highlight other emerging trends as they take shape. 

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