Building a Case for Worry

We discussed on Monday that large cap stocks had taken leadership versus small cap The Dow Jones Industrial Average is flirting with 12,000, and the media is enamored with the prospect of the move again. However the more interesting move is the S&P 500 stalking the 1300 level. The move would put the index above the October 2008 high and bring the May 2008 high squarely into view at 1425. That is significant in technical terms, but a lack of participation or leadership from the small cap stocks does raise concern relative to sustainability of the move. It may never amount to anything, but it a warning sign worthy of watching.

The 2007 high water mark for the S&P 600 Small Cap index is 442 roughly 4% above the current levels. The S&P 500 index needs to gain 9.6% to reach the next milestone (1425). The S&P 600 index broke below the 20 day moving average and tested the 50 day. The performance of the small cap index versus the Dow and S&P 500 has taken a turn lower indicating some divergence short term.

The transportation sector is showing signs of struggles with the Shippers lagging along with the Airlines. The airlines have been slowly moving lower since the fourth quarter, but shipping made a big turn lower the last four weeks. Is it rising fuel costs, less travel, less shipping or all of the above? Fuel costs are rising and squeezing margins in the transports and fuel surcharges are starting to crop up again. IYT broke its trendline similar to the small cap index. Both remain above the 50 day moving average for now, but we have to watch the outcome of the current activity.

Technically the data is showing worry relative to the markets continued advance. On-balance volume is confirming the index slowing activity, in fact, there is higher volume on down days than up days, another sign of weakness in specific sectors. The Relative Strength Index for the major indexes has shown a drop as investor make adjustments to portfolios. Money flow has been steady, but dropped to the lower end of the range the last two weeks. All signs of worry, but not sell signals.

As we have discussed several time, commodities are slowing short term. This may be a short term event or it could be a trend change. Worry in the precious metals are obvious with gold and silver both moving lower. Base metals have slowed and Asia is the cause according to analyst. China’s attempt to control inflation is some of the cause, but the global economy is not hitting on all cylinders despite the optimism.

More sovereign debt issues, this time in Japan? Standard & Poors cut the rating on Japan’s sovereign debt. The impact has caused some concern in Asia, but it will take time to determine the outcome. As we have seen in Europe the bark is worse than the bite, if the right steps are take to correct the situation. Japan is in a position of having to deal with high debt levels and stagnate growth. The outcome will depend on government policy going forward and as we know that can take time. The case for worry is building against Japan after showing promise the last six months.

All total, none of this ‘worry’ is enough to scream fire and run for the exits. However, planning your potential escape route should the smoke turn out to be a fire is always prudent. Currently the market is experiencing sector rotation and it is either causing the worries or investors are reacting to the concerns/worries. Regardless of the why, having an exit strategy is the difference between winning and losing. Having a defined plan also elimates worry and reationary investing mistakes.

Jim Farrish is the Founder and Editor of SectorExchange.com and TheETFexchange.com as well as the CEO of Money Strategies, Inc., a Registered Investment Adviser with the SEC. The company and/or its clients may hold positions in the ETFs, mutual funds and/or index funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. Investors who are interested in money management services may visit the Money Strategies, Inc., web site.